Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-21186

February 27, 1924

FREDERICK C. FISHER, plaintiff-appellee,

vs.
WENCESLAO TRINIDAD, Collector of International Revenue, defendant-appellant.
Attorney-General Villa-Real for appellant.
Fisher DeWitt, Perkins and Brady and Johns R. McFie, Jr., for appellee.
STATEMENT
October 19, 1920, the plaintiff, a resident of the City of Manila, filed a complaint against the
defendant as Collector of Internal Revenue, in which he alleged that he was a shareholder in the
Philippine-American Drug Company, a domestic corporation; that in the year 1919, he received
from the drug company certificates of shares of the par value of P24,800, as his proportionate
share of a stock dividend, duly and lawfully declared by the company; that the defendant
erroneously and unlawfully, and against the will and protest of the plaintiff, required him to pay
an income tax on such stock dividend in the amount of P899.91; that plaintiff paid the tax under
protest, and made a written demand upon the defendant for its return, which was refused, and
plaintiff prays for judgment for the amount, with interest and costs.
A demurrer was filed to the complaint upon the ground that it "does not state facts sufficient to
constitute a cause of action," which was sustained by the trial court, and the plaintiff, refusing to
plead further, the complaint was dismissed. From which ruling the plaintiff appealed to this court
where the decision of the lower court was reversed by this court,1 and the case was remanded to
the lower court for further proceedings not inconsistent with the opinion.
The defendant filed an answer, denying all of the material allegations of the complaint, and as a
further and special defense, alleged that the stock dividend in question "represented and was
declared and paid out of the earnings and profits earned by and accrued to the said PhilippineAmerican Drug Company since March 1, 1913, and distributed by said corporation among its
stockholders;" that the par value of the stock "did not exceed the amount of the earnings and
profits actually earned by the corporation;" and that by reason thereof the defendant levied the
tax in question, which was paid under protest.
The case was tried and submitted upon an agreed statement of facts, and the court rendered
judgment in favor of the plaintiff for the amount of P899.91, without interest and costs, from
which decision the defendant appeals, contending:

I. The court below erred in holding that the Philippine Legislature had no power to tax a
stock dividend as income in an income tax law.
II. The court below erred in not passing on the constitutional question raised.
III. The court below erred in rendering judgment for the plaintiff.

JOHNS, J.:
December 14, 1923, after the appeal was perfected, the plaintiff wrote the defendant a letter in
which he said:
Please be advised that I hereby withdraw the protest heretofore made by me on the 30th
day of March, 1920, in connection with income tax in the amount of P899.91 assessed by
you on shares of the Philippine-American Drug Company of the par value of P24,800.
This was later confirmed by another letter addressed to this court stating in substance that the
plaintiff had withdrawn and did not rely upon his protest because he had since sold the stock in
question. Notwithstanding that fact, the Attorney-General insists upon a decision by this court on
the merits, and in particular as to the constitutionality of the law and the legal right of the
defendant to levy and collect the tax in question.
The plaintiff contends that the record now presents a moot case, and for such there is nothing left
for this court to decide. That contention must be sustained. The payment of the money under
protest was the basis of plaintiff's action, without which it could not be sustained. His protest is
now withdrawn. The legal effect of it is to withdraw his complaint and to place the whole matter
in the same position as if no protest had ever been made. It must be conceded that in the absence
of a protest the action could not be maintained. In other words, the plaintiff is now in court
seeking to recover money which was not paid under protest. It is true that the plaintiff obtained
judgment against the defendant in the lower court, but in legal effect the withdrawal of the
protest was a waiver of all of plaintiff's rights under that judgment. For such reason, there is
nothing left for this court to decide.
Without passing upon the merits of the question involved or the constitutionality of the act or the
right of the defendant to levy the tax in question, the judgment of the lower court is reversed, and
plaintiff's complaint is dismissed, with judgment for costs in both this and the lower court against
the plaintiff and in favor of the defendant. So ordered.

EN BANC

FORT BONIFACIO
DEVELOPMENT
CORPORATION

G.R. No. 158885

Petitioner,

- versus -

COMMISSIONER OF INTERNAL
REVENUE, REGIONAL
DIRECTOR, REVENUE REGION
NO. 8, and CHIEF, ASSESSMENT
DIVISION, REVENUE REGION
NO. 8, BIR,
Respondents.

x-----------------------------------------x
FORT BONIFACIO
DEVELOPMENT
CORPORATION
Petitioner,

- versus -

G.R. No. 170680

COMMISSIONER OF INTERNAL Present:

REVENUE, REVENUE DISTRICT
3

OFFICER, REVENUE DISTRICT

NO. 44, TAGUIG and PATEROS,
BUREAU OF INTERNAL
REVENUE.

Respondents.

PUNO, C.J.,
QUISUMBING,*
YNARES-SANTIAGO,
CARPIO,
CORONA,
CARPIO MORALES,
CHICO-NAZARIO,
VELASCO, JR.,
NACHURA,
LEONARDO-DE CASTRO,
BRION,**
PERALTA,
BERSAMIN,
DEL CASTILLO, and
ABAD, JJ.

Promulgated:

October 2, 2009
x-----------------------------------------------------------------------------------------x

RE S O LUTI O N

*
**
4

LEONARDO-DE CASTRO, J.:

Before us is respondents Motion for Reconsideration of our Decision dated

April 2, 2009 which granted the consolidated petitions of petitioner Fort Bonifacio
Development Corporation, the dispositive portion of which reads:

WHEREFORE, the petitions are GRANTED. The assailed decisions of the

Court of Tax Appeals and the Court of Appeals are REVERSED and SET ASIDE.
Respondents are hereby (1) restrained from collecting from petitioner the amount of
P28,413,783.00 representing the transitional input tax credit due it for the fourth
quarter of 1996; and (2) directed to refund to petitioner the amount of
P347,741,695.74 paid as output VAT for the third quarter of 1997 in light of the
persisting transitional input tax credit available to petitioner for the said quarter, or
to issue a tax credit corresponding to such amount. No pronouncement as to costs.

The Motion for Reconsideration raises the following arguments:

SECTION 100 OF THE OLD NATIONAL INTERNAL

REVENUE CODE (OLD NIRC), AS AMENDED BY REPUBLIC
ACT (R.A.) NO. 7716, COULD NOT HAVE SUPPLIED THE
DISTINCTION BETWEEN THE TREATMENT OF REAL
PROPERTIES OR REAL ESTATE DEALERS ON THE ONE
HAND, AND THE TREATMENT OF TRANSACTIONS
INVOLVING OTHER COMMERCIAL GOODS ON THE OTHER
HAND, AS SAID DISTINCTION IS FOUND IN SECTION 105
AND, SUBSEQUENTLY, REVENUE REGULATIONS NO. 7-95
WHICH DEFINES THE INPUT TAX CREDITABLE TO A REAL

ESTATE DEALER WHO BECOMES SUBJECT TO VAT FOR

THE FIRST TIME.
II
SECTION 4.105.1 AND PARAGRAPH (A) (III) OF THE
TRANSITORY PROVISIONS OF REVENUE REGULATIONS
NO. 7-95 VALIDLY LIMIT THE 8% TRANSITIONAL INPUT
TAX TO THE IMPROVEMENTS ON REAL PROPERTIES.
III
REVENUE REGULATIONS NO. 6-97 DID NOT REPEAL
REVENUE REGULATIONS NO. 7-95.

The instant motion for reconsideration lacks merit.

The first VAT law, found in Executive Order (EO) No. 273 [1987], took
effect on January 1, 1988. It amended several provisions of the National Internal
Revenue Code of 1986 (Old NIRC). EO 273 likewise accommodated the potential
burdens of the shift to the VAT system by allowing newly VAT-registered persons
to avail of a transitional input tax credit as provided for in Section 105 of the Old
NIRC. Section 105 as amended by EO 273 reads:

Sec. 105. Transitional Input Tax Credits. A person who becomes liable
to value-added tax or any person who elects to be a VAT-registered person shall,
subject to the filing of an inventory as prescribed by regulations, be allowed input
tax on his beginning inventory of goods, materials and supplies equivalent to 8% of
the value of such inventory or the actual value-added tax paid on such goods,
materials and supplies, whichever is higher, which shall be creditable against the
output tax.
6

RA 7716 took effect on January 1, 1996. It amended Section 100 of the Old
NIRC by imposing for the first time value-added-tax on sale of real properties. The
amendment reads:

Sec. 100. Value-added-tax on sale of goods or properties. (a) Rate and

base of tax. There shall be levied, assessed and collected on every sale, barter
or exchange of goods or properties, a value-added tax equivalent to 10% of the
gross selling price or gross value in money of the goods, or properties sold,
bartered or exchanged, such tax to be paid by the seller or transferor.
(1) The term 'goods or properties' shall mean all tangible and intangible
objects which are capable of pecuniary estimation and shall include:
(A) Real properties held primarily for sale to customers or
held for lease in the ordinary course of trade or business; xxx

The provisions of Section 105 of the NIRC, on the transitional input tax
credit, remain intact despite the enactment of RA 7716. Section 105 however was
amended with the passage of the new National Internal Revenue Code of 1997
(New NIRC), also officially known as Republic Act (RA) 8424. The provisions on
the transitional input tax credit are now embodied in Section 111(A) of the New
NIRC, which reads:

Section 111. Transitional/Presumptive Input Tax Credits.

(A) Transitional Input Tax Credits. - A person who becomes liable to value-added
tax or any person who elects to be a VAT-registered person shall, subject to the
filing of an inventory according to rules and regulations prescribed by the
Secretary of finance, upon recommendation of the Commissioner, be allowed input
tax on his beginning inventory of goods, materials and supplies equivalent for 8%
7

of the value of such inventory or the actual value-added tax paid on such goods,
materials and supplies, whichever is higher, which shall be creditable against the
output tax. [Emphasis ours.]

The Commissioner of Internal Revenue (CIR) disallowed Fort Bonifacio

Development Corporations (FBDC) presumptive input tax credit arising from the
land inventory on the basis of Revenue Regulation 7-95 (RR 7-95) and Revenue
Memorandum Circular 3-96 (RMC 3-96). Specifically, Section 4.105-1 of RR 795 provides:

Sec. 4.105-1. Transitional input tax on beginning inventories. Taxpayers

who became VAT-registered persons upon effectivity of RA No. 7716 who have
exceeded the minimum turnover of P500,000.00 or who voluntarily register even if
their turnover does not exceed P500,000.00 shall be entitled to a presumptive input
tax on the inventory on hand as of December 31, 1995 on the following: (a) goods
purchased for resale in their present condition; (b) materials purchased for further
processing, but which have not yet undergone processing; (c) goods which have
been manufactured by the taxpayer; (d) goods in process and supplies, all of which
are for sale or for use in the course of the taxpayers trade or business as a VATregistered person.
However, in the case of real estate dealers, the basis of the presumptive
input tax shall be the improvements, such as buildings, roads, drainage systems,
and other similar structures, constructed on or after the effectivity of EO 273
(January 1, 1988).
The transitional input tax shall be 8% of the value of the inventory or actual
VAT paid, whichever is higher, which amount may be allowed as tax credit against
the output tax of the VAT-registered person.

In the April 2, 2009 Decision sought to be reconsidered, the Court struck

down Section 4.105-1 of RR 7-95 for being in conflict with the law. It held that
the CIR had no power to limit the meaning and coverage of the term goods in
8

Section 105 of the Old NIRC sans statutory authority or basis and justification to
make such limitation. This it did when it restricted the application of Section 105
in the case of real estate dealers only to improvements on the real property
belonging to their beginning inventory.

A law must not be read in truncated parts; its provisions must be read in
relation to the whole law. It is the cardinal rule in statutory construction that a
statutes clauses and phrases must not be taken as detached and isolated
expressions, but the whole and every part thereof must be considered in fixing the
meaning of any of its parts in order to produce a harmonious whole. Every part of
the statute must be interpreted with reference to the context, i.e., that every part of
the statute must be considered together with other parts of the statute and kept
subservient to the general intent of the whole enactment.1[1]

In construing a statute, courts have to take the thought conveyed by the

statute as a whole; construe the constituent parts together; ascertain the legislative
intent from the whole act; consider each and every provision thereof in the light of
the general purpose of the statute; and endeavor to make every part effective,
harmonious and sensible.2[2]

1
2
9

The statutory definition of the term goods or properties leaves no room for
doubt. It states:

Sec. 100. Value-added tax on sale of goods or properties. (a) Rate and
base of tax. xxx.
(1) The term goods or properties shall mean all tangible and intangible
objects which are capable of pecuniary estimation and shall include:
(A) Real properties held primarily for sale to customers or
held for lease in the ordinary course of trade or business; xxx.

The amendatory provision of Section 105 of the NIRC, as introduced by RA

7716, states:

Sec. 105. Transitional Input tax Credits. A person who becomes liable to
value-added tax or any person who elects to be a VAT-registered person shall, subject
to the filing of an inventory as prescribed by regulations, be allowed input tax on his
beginning inventory of goods, materials and supplies equivalent to 8% of the value of
such inventory or the actual value-added tax paid on such goods, materials and
supplies, whichever is higher, which shall be creditable against the output tax.

The term goods or properties by the unambiguous terms of Section 100

includes real properties held primarily for sale to costumers or held for lease in
the ordinary course of business. Having been defined in Section 100 of the
NIRC, the term goods as used in Section 105 of the same code could not have a
different meaning. This has been explained in the Decision dated April 2, 2009,
thus:
10

Under Section 105, the beginning inventory of "goods" forms part of the
valuation of the transitional input tax credit. Goods, as commonly understood in
the business sense, refers to the product which the VAT-registered person offers
for sale to the public. With respect to real estate dealers, it is the real properties
themselves which constitute their "goods." Such real properties are the operating
assets of the real estate dealer.
Section 4.100-1 of RR No. 7-95 itself includes in its enumeration of
"goods or properties" such "real properties held primarily for sale to customers or
held for lease in the ordinary course of trade or business." Said definition was
taken from the very statutory language of Section 100 of the Old NIRC. By
limiting the definition of goods to "improvements" in Section 4.105-1, the BIR
not only contravened the definition of "goods" as provided in the Old NIRC, but
also the definition which the same revenue regulation itself has provided.

Section 4.105-1 of RR 7-95 restricted the definition of goods, viz:

However, in the case of real estate dealers, the basis of the presumptive input
tax shall be the improvements, such as buildings, roads, drainage systems, and other
similar structures, constructed on or after the effectivity of EO 273 (January 1, 1988).

As mandated by Article 7 of the Civil Code, 3[3] an administrative rule or

regulation cannot contravene the law on which it is based. RR 7-95 is inconsistent
with Section 105 insofar as the definition of the term goods is concerned. This
is a legislative act beyond the authority of the CIR and the Secretary of Finance.
The rules and regulations that administrative agencies promulgate, which are the
product of a delegated legislative power to create new and additional legal
provisions that have the effect of law, should be within the scope of the statutory
authority granted by the legislature to the objects and purposes of the law, and

3
11

should not be in contradiction to, but in conformity with, the standards prescribed
by law.

To be valid, an administrative rule or regulation must conform, not

contradict, the provisions of the enabling law. An implementing rule or regulation
cannot modify, expand, or subtract from the law it is intended to implement. Any
rule that is not consistent with the statute itself is null and void. 4[4]

While administrative agencies, such as the Bureau of Internal Revenue, may

issue regulations to implement statutes, they are without authority to limit the
scope of the statute to less than what it provides, or extend or expand the statute
beyond its terms, or in any way modify explicit provisions of the law. Indeed, a
quasi-judicial body or an administrative agency for that matter cannot amend an
act of Congress. Hence, in case of a discrepancy between the basic law and an
interpretative or administrative ruling, the basic law prevails.5[5]

To recapitulate, RR 7-95, insofar as it restricts the definition of goods as

basis of transitional input tax credit under Section 105 is a nullity.

4
5
12

On January 1, 1997, RR 6-97 was issued by the Commissioner of Internal

Revenue. RR 6-97 was basically a reiteration of the same Section 4.105-1 of RR
7-95, except that the RR 6-97 deleted the following paragraph:

However, in the case of real estate dealers, the basis of the presumptive
input tax shall be the improvements, such as buildings, roads, drainage systems,
and other similar structures, constructed on or after the effectivity of E.O. 273
(January 1, 1988).

It is clear, therefore, that under RR 6-97, the allowable transitional input tax
credit is not limited to improvements on real properties. The particular provision
of RR 7-95 has effectively been repealed by RR 6-97 which is now in consonance
with Section 100 of the NIRC, insofar as the definition of real properties as goods
is concerned. The failure to add a specific repealing clause would not necessarily
indicate that there was no intent to repeal RR 7-95. The fact that the aforequoted
paragraph was deleted created an irreconcilable inconsistency and repugnancy
between the provisions of RR 6-97 and RR 7-95.

We now address the points raised in the dissenting opinion of the Honorable
Justice Antonio T. Carpio.

At the outset, it must be stressed that FBDC sought the refund of the total
amount of P347,741,695.74 which it had itself paid in cash to the BIR. It is
argued that the transitional input tax credit applies only when taxes were
13

previously paid on the properties in the beginning inventory and that there should
be a law imposing the tax presumed to have been paid. The thesis is anchored on
the argument that without any VAT or other input business tax imposed by law on
the real properties at the time of the sale, the 8% transitional input tax cannot be
presumed to have been paid.

The language of Section 105 is explicit. It precludes reading into the law
that the transitional input tax credit is limited to the amount of VAT previously
paid. When the aforesaid section speaks of eight percent (8%) of the value of
such inventory followed by the clause or the actual value-added tax paid on
such goods, materials and supplies, the implication is clear that under the first
clause, eight percent (8%) of the value of such inventory, the law does not
contemplate the payment of any prior tax on such inventory. This is distinguished
from the second clause, the actual value-added tax paid on the goods, materials
and supplies where actual payment of VAT on the goods, materials and supplies is
assumed. Had the intention of the law been to limit the amount to the actual VAT
paid, there would have been no need to explicitly allow a claim based on 8% of the
value of such inventory.

The contention that the 8% transitional input tax credit in Section 105
presumes that a previous tax was paid, whether or not it was actually paid, requires
a transaction where a tax has been imposed by law, is utterly without basis in law.
The rationale behind the provisions of Section 105 was aptly elucidated in the
Decision sought to be reconsidered, thus:
14

It is apparent that the transitional input tax credit operates to benefit newly
VAT-registered persons, whether or not they previously paid taxes in the
acquisition of their beginning inventory of goods, materials and supplies. During
that period of transition from non-VAT to VAT status, the transitional input tax
credit serves to alleviate the impact of the VAT on the taxpayer. At the very
beginning, the VAT-registered taxpayer is obliged to remit a significant portion of
the income it derived from its sales as output VAT. The transitional input tax
credit mitigates this initial diminution of the taxpayers income by affording the
opportunity to offset the losses incurred through the remittance of the output VAT
at a stage when the person is yet unable to credit input VAT payments.

As pointed out in Our Decision of April 2, 2009, to give Section 105 a

restrictive construction that transitional input tax credit applies only when taxes
were previously paid on the properties in the beginning inventory and there is a
law imposing the tax which is presumed to have been paid, is to impose conditions
or requisites to the application of the transitional tax input credit which are not
found in the law. The courts must not read into the law what is not there. To do so
will violate the principle of separation of powers which prohibits this Court from
engaging in judicial legislation.6[6]

WHEREFORE, premises considered, the Motion for Reconsideration is DENIED WITH

FINALITY for lack of merit.

SO ORDERED.

6
15

EN BANC
[G.R. No. L-9408. October 31, 1956.]
EMILIO Y. HILADO, Petitioner, vs. THE COLLECTOR OF INTERNAL REVENUE and
THE COURT OF TAX APPEALS, Respondents.
DECISION
BAUTISTA ANGELO, J.:
On March 31, 1952, Petitioner filed his income tax return for 1951 with the treasurer of Bacolod
City wherein he claimed, among other things, the amount of P12,837.65 as a deductible item
from his gross income pursuant to General Circular No. V-123 issued by the Collector of Internal
Revenue. This circular was issued pursuant to certain rules laid down by the Secretary of Finance
On the basis of said return, an assessment notice demanding the payment of P9,419 was sent to
Petitioner, who paid the tax in monthly installments, the last payment having been made on
January 2, 1953.
Meanwhile, on August 30, 1952, the Secretary of Finance, through the Collector of Internal
Revenue, issued General Circular No. V-139 which not only revoked and declared void his
general Circular No. V- 123 but laid down the rule that losses of property which occurred during
the period of World War II from fires, storms, shipwreck or other casualty, or from robbery, theft,
or embezzlement are deductible in the year of actual loss or destruction of said property. As a
consequence, the amount of P12,837.65 was disallowed as a deduction from the gross income of
Petitioner for 1951 and the Collector of Internal Revenue demanded from him the payment of
the sum of P3,546 as deficiency income tax for said year. When the petition for reconsideration
filed by Petitioner was denied, he filed a petition for review with the Court of Tax Appeals. In
due time, this court rendered decision affirming the assessment made by Respondent Collector of
Internal Revenue. This is an appeal from said decision.
It appears that Petitioner claimed in his 1951 income tax return the deduction of the sum of
P12,837.65 as a loss consisting in a portion of his war damage claim which had been duly
approved by the Philippine War Damage Commission under the Philippine Rehabilitation Act of
1946 but which was not paid and never has been paid pursuant to a notice served upon him by
said Commission that said part of his claim will not be paid until the United States Congress
should make further appropriation. He claims that said amount of P12,837.65 represents a
business asset within the meaning of said Act which he is entitled to deduct as a loss in his
return for 1951. This claim is untenable.
To begin with, assuming that said a mount represents a portion of the 75% of his war damage
claim which was not paid, the same would not be deductible as a loss in 1951 because, according
to Petitioner, the last installment he received from the War Damage Commission, together with
the notice that no further payment would be made on his claim, was in 1950. In the circumstance,
16

said amount would at most be a proper deduction from his 1950 gross income. In the second
place, said amount cannot be considered as a business asset which can be deducted as a loss in
contemplation of law because its collection is not enforceable as a matter of right, but is
dependent merely upon the generosity and magnanimity of the U. S. government. Note that, as of
the end of 1945, there was absolutely no law under which Petitioner could claim compensation
for the destruction of his properties during the battle for the liberation of the Philippines. And
under the Philippine Rehabilitation Act of 1946, the payments of claims by the War Damage
Commission merely depended upon its discretion to be exercised in the manner it may see fit,
but the non-payment of which cannot give rise to any enforceable right, for, under said Act, All
findings of the Commission concerning the amount of loss or damage sustained, the cause of
such loss or damage, the persons to whom compensation pursuant to this title is payable, and the
value of the property lost or damaged, shall be conclusive and shall not be reviewable by any
court. (section 113).
It is true that under the authority of section 338 of the National Internal Revenue Code the
Secretary of Finance, in the exercise of his administrative powers, caused the issuance of General
Circular No. V-123 as an implementation or interpretative regulation of section 30 of the same
Code, under which the amount of P12,837.65 was allowed to be deducted in the year the last
installment was received with notice that no further payment would be made until the United
States Congress makes further appropriation therefor, but such circular was found later to be
wrong and was revoked. Thus, when doubts arose as to the soundness or validity of such circular,
the Secretary of Finance sought the advice of the Secretary of Justice who, accordingly, gave his
opinion the pertinent portion of which reads as follows:
chanroblesvirtuallawlibrary

Yet it might be argued that war losses were not included as deductions for the year when they
were sustained because the taxpayers had prospects that losses would be compensated for by the
United States Government; that since only uncompensated losses are deductible, they had to
wait until after the determination by the Philippine War Damage Commission as to the
compensability in part or in whole of their war losses so that they could exclude from the
deductions those compensated for by the said Commission;
and that, of necessity, such
determination could be complete only much later than in the year when the loss was sustained.
This contention falls to the ground when it is considered that the Philippine Rehabilitation Act
which authorized the payment by the United States Government of war losses suffered by
property owners in the Philippines was passed only on August 30, 1946, long after the losses
were sustained. It cannot be said therefore, that the property owners had any conclusive
assurance during the years said losses were sustained, that the compensation was to be paid
therefor. Whatever assurance they could have had, could have been based only on some
information less reliable and less conclusive than the passage of the Act itself. Hence, as diligent
property owners, they should adopt the safest alternative by considering such losses deductible
during the year when they were sustained.
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In line with this opinion, the Secretary of Finance, through the Collector of Internal Revenue,
issued General Circular No. V-139 which not only revoked and declared void his previous
Circular No. V 123 but laid down the rule that losses of property which occurred during the
period of World War II from fires, storms, shipwreck or other casualty, or from robbery, theft, or
embezzlement are deductible for income tax purposes in the year of actual destruction of said
property. We can hardly argue against this opinion. Since we have already stated that the amount
claimed does not represent a business asset that may be deducted as a loss in 1951, it is clear
17

that the loss of the corresponding asset or property could only be deducted in the year it was
actually sustained. This is in line with section 30 (d) of the National Internal Revenue Code
which prescribes that losses sustained are allowable as deduction only within the corresponding
taxable year.
Petitioners contention that during the last war and as a consequence of enemy occupation in the
Philippines there was no taxable year within the meaning of our internal revenue laws because
during that period they were unenforceable, is without merit. It is well known that our internal
revenue laws are not political in nature and as such were continued in force during the period of
enemy occupation and in effect were actually enforced by the occupation government. As a
matter of fact, income tax returns were filed during that period and income tax payment were
effected and considered valid and legal. Such tax laws are deemed to be the laws of the occupied
territory and not of the occupying enemy.
Furthermore, it is a legal maxim, that excepting that of a political nature, Law once established
continues until changed by some competent legislative power. It is not changed merely by
change of sovereignty. (Joseph H. Beale, Cases on Conflict of Laws, III, Summary section 9,
citing Commonwealth vs. Chapman, 13 Met., 68.) As the same author says, in his Treatise on the
Conflict of Laws (Cambridge, 1916, section 131): There can be no break or interregnun in
law. From the time the law comes into existence with the first-felt corporateness of a primitive
people it must last until the final disappearance of human society. Once created, it persists until a
change takes place, and when changed it continues in such changed condition until the next
change and so forever. Conquest or colonization is impotent to bring law to an end; inspite of
change of constitution, the law continues unchanged until the new sovereign by legislative act
creates a change. (Co Kim Chan vs. Valdes Tan Keh and Dizon, 75 Phil., 113, 142-143.)
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It is likewise contended that the power to pass upon the validity of General Circular No. V-123 is
vested exclusively in our courts in view of the principle of separation of powers and, therefore,
the Secretary of Finance acted without valid authority in revoking it and approving in lieu
thereof General Circular No. V-139. It cannot be denied, however, that the Secretary of Finance
is vested with authority to revoke, repeal or abrogate the acts or previous rulings of his
predecessor in office because the construction of a statute by those administering it is not binding
on their successors if thereafter the latter become satisfied that a different construction should be
given. [Association of Clerical Employees vs. Brotherhood of Railways & Steamship Clerks, 85
F. (2d) 152, 109 A.L.R., 345.]
When the Commissioner determined in 1937 that the Petitioner was not exempt and never had
been, it was his duty to determine, assess and collect the tax due for all years not barred by the
statutes of limitation. The conclusion reached and announced by his predecessor in 1924 was not
binding upon him. It did not exempt the Petitioner from tax, This same point was decided in this
way in Stanford University Bookstore, 29 B. T. A., 1280; affd., 83 Fed. (2d) 710. (Southern
Maryland Agricultural Fair Association vs. Commissioner of Internal Revenue, 40 B. T. A., 549,
554).
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With regard to the contention that General Circular No. V-139 cannot be given retroactive effect
because that would affect and obliterate the vested right acquired by Petitioner under the
previous circular, suffice it to say that General Circular No. V-123, having been issued on a
wrong construction of the law, cannot give rise to a vested right that can be invoked by a

18

taxpayer. The reason is obvious: a vested right cannot spring from a wrong interpretation. This
is too clear to require elaboration.
chanrobl esvirtuallawlibrary

It seems too clear for serious argument that an administrative officer cannot change a law
enacted by Congress. A regulation that is merely an interpretation of the statute when once
determined to have been erroneous becomes nullity. An erroneous construction of the law by the
Treasury Department or the collector of internal revenue does not preclude or estop the
government from collecting a tax which is legally due. (Ben Stocker, et al., 12 B. T. A., 1351.)
Art. 2254. No vested or acquired right can arise from acts or omissions which are against the
law or which infringe upon the rights of others. (Article 2254, New Civil Code.)
Wherefore, the decision appealed from is affirmed Without pronouncement as to costs.

19

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. 156

September 27, 1946

MILTON GREENFIELD, plaintiff-appellant,

vs.
BIBIANO L. MEER, defendant-appellee.
Francisco Dalupan for appellant.
First Assistant Solicitor General Reyes and Solicitor Arguelles for appellee.
FERIA, J.:
This is an appeal from the decision of the Court of First Instance of Manila which dismisses the
complaint of the plaintiff and appellant containing two causes of action; one to recover the sum
of P9,008.14 paid as income tax for the year 1939 by plaintiff to defendant under protest, by
reason of defendant having disallowed a deduction of P67,307.80 alleged by plaintiff to be losses
in his trade or business; and the other to reclaim, in the event the first cause of action is
dismissed, the sum of P475 collected by defendant from plaintiff illegally according to the latter,
because the former has erroneously computed the tax on personal and additional exemptions.
The following are the pertinent facts stipulated and submitted by the parties to the lower court:
2. That since the year 1933 up to the present time, the plaintiff has been continuously
engaged in the embroidery business located at 385 Cristobal, City of Manila and carried
on under his name;
3. That in 1935 the plaintiff began engaging in buying and selling mining stocks and
securities for his own exclusive account and not for the account of others . . .;
4. That Exhibit A attached to the complaint and made a part hereof represents plaintiff's
purchases and sales of each class of stock and security as well as the profits and losses
resulting on each class during the year 1939;
5. That the plaintiff has not been a dealer in securities as defined in section 84 (t) of
Commonwealth Act No. 466; that he has no established place of business for the
20

purchase and sale of mining stocks and securities; and that he was never a member of any
stock exchange;
6. That the plaintiff filed an income tax return for the calendar year 1939 showing that he
made a net profit amounting to P52,449.29 on embroidery business and P17,850 on
dividends from various corporations; and that from the purchase and sales of mining
stocks and securities he made a profit of P10,741.30 and incurred losses in the amount of
P78,049.10, thereby sustaining a net loss of P67,307.80, which income tax return is
hereto attached and marked Exhibit B;
7. That in said income tax return for 1939, the plaintiff declared the results of his stock
transactions under Schedule B (Income from Business);but the defendant ruled that they
should be declared in the income tax return, Exhibit B, under Schedule D (Gains and
Losses from Sales or Exchanges of Capital Assets, real or personal);
8. That in said income tax return, said plaintiff claims his deduction of P67,307.80
representing the net loss sustained by him in mining stocks securities during the year
1939; and that the defendant disallowed said item of deduction on the ground that said
losses were sustained by the plaintiff from the sale of mining stocks and securities which
are capital assets, and that the loss arising from the sale of the same should be allowed
only to the extent of the gains from such sales, which gains were already taken into
consideration in the computation of the alleged net loss of P67,307.80;
9. That the defendant assessed plaintiff's income tax return for the year 1939 at
P13,771.06 as shown in the following computation appearing in the audit sheet of the
defendant hereto attached and marked Exhibit C;

Net income as per return of plaintiff for 1939

P70,299.29

Add: Net Loss on sale of mining stocks and

securities disallowed in audit

67,307.80

Total net income as per office audit

Amount of tax on net income as per office

audit

P137,607.09
=========

P13,821.06

21

Less: Tax on exemptions:

Personal exemption

Additional exemption

Total

Tax on exemption

Net amount of tax due

P2,500.00

1,000.00

P3,500.00

50.00

P13,771.06
=========

10. That the defendant computed the graduated rate of income tax due on the entire net
income as per office audit, without first deducting therefrom the amount of personal and
additional exemptions to which the plaintiff is entitled, allowing said plaintiff a deduction
from the assessed tax the amount of P50 corresponding to the exemption of P3,500;
11. That the plaintiff, objecting and excepting to all the ruling of the defendant above
mentioned and in assessing plaintiff with P13,771.06, claimed from the defendant the
refund of P9,008.14 or in the alternative case P475, which claim of plaintiff was
overruled by the defendant;
The questions raised by appellant in his four (4) assignments of error may be reduced into the
following: (1) Whether the losses sustained by the plaintiff from the buying and selling of mining
securities during the year 1939 are losses incurred in trade and business, deductible under section
30 (d) (1)(A) of Commonwealth Act No. 466 from his gains in his embroidery business and other
income; or whether they are capital losses from sales of capital assets which shall be allowed
only to the extent of the gains from such sales under section 34 of the same Commonwealth Act
No. 466. And (2) whether, under the present law, the personal and additional exemptions granted
by section 23 of the same Act, should be considered as a credit against or be deducted from the
net income, or whether it is the tax on such exemptions that should be deducted from the tax on
the total net income.

22

1. As to the first question, it is agreed in the above-quoted stipulation of facts that the plaintiff
was not a dealer in securities or share of stock as defined in section 84 (t) of Commonwealth Act
No. 466. The question for determination is whether appellant, though not a dealer in mining
securities, may be considered as engaged in the business of buying and selling them under
section 30 (d), (1) (A) of said Act No. 466.
It is evident that, taking into consideration the nature of mining securities, which may be bought
or sold either as a business or for speculation purposes only, the National Assembly of the
Philippines has deemed it necessary to define or determine beforehand in section 84 (t) of
Commonwealth Act No. 466 who may be considered as persons engaged in the trade or business
of buying and selling securities within the meaning of the phrase "incurred in trade or business"
used in section 30 (d) (1) (A) of the same Act, in order to avoid any question or doubt as to
deductibility of all losses incurred by a merchant in securities from his net income from whatever
source. The definition of dealer or merchant in securities given in said section 84 (t) includes
persons, natural or juridical, who are engaged in the purchase and sale of securities whether for
his their own account or for others, provided they have a place of business and are regularly
engaged therein. There was formerly some doubt or question as to whether a person engaged in
buying or selling securities for his own account might be considered as engaged in that trade or
business, and several cases involving such question had been submitted to the United States
Federal Courts for ruling, and to the Income Tax Units of the United States Bureau of Internal
Revenue for opinion. But with the inclusive definition of the term "dealer" or merchant of
securities given in section 84 (t) of Act No. 466, such doubt can no longer arise.
Said section 84 (t) reads as follows:
(t) The term "dealer in securities" means a merchant of stocks or securities, whether an
individual, partnership, or corporation, with an established place of business, regularly
engaged in the purchase of securities and their resale of customers; that is, one who as a
merchant buys securities and sells them to customers with a view to the gains and profits
that may be derived therefrom.
Appellant assumes, however, that the above-quoted definition does not cover or include all
persons engaged in the trade or business of buying and selling securities within the meaning of
said section 30 (d) (1) (A). He contends that, although he is not a dealer in mining securities, he
may be considered as having been engaged in the trade or business of buying and selling
securities. And in support of his contention appellant quotes Opinion No. 1818 of the Income Tax
Unit of the United States Bureau of Internal Revenue(I.T. No. 1818, C.B. II, pp. 39-41), in which
opinion the following was said:
The taxpayer is not a member of any stock exchange, has no place of business, and does
not make purchase and sales of securities for customers. Much of his trading is done on
margin. He devotes the greater part of the time in his broker's office keeping in touch
with the market. He has no other trade or business, his income consisting entirely of
interest bonds, dividends on stocks, and profits from the sale or disposition of securities.

23

Advice is requested (1) whether this taxpayer is entitled to the benefit of section 204 of
the Revenue Act of 1921, with reference to a net loss incurred in 1921, from the sale of
stocks; (2) whether he is entitled to the benefit of section 206 of the Revenue Act of 1921,
with regard to gains derived in 1922 from the sale of two blocks of stock held more than
two years.
1. Section 204 (a) provides in part:
That as used in this section the term "net loss" means only net losses resulting from the
operation of any trade or business regularly carried on by the taxpayer . . .
The question is, than, whether the taxpayer was regularly engaged in the trade or business
of buying and selling securities.
The interpretation placed upon the term "business or trade" by the courts and the
department may be indicated by a few illustrative decisions. In two early cases (In re
Marson [1871], Fed. Cas. No. 9142, and In re Woodward [1876], Fed. Cas. No. 18001) it
was held that a speculator in stocks was not a "merchant or tradesman" within the
meaning of the Bankruptcy Act of 1867. It was said in the former case:
"The only business he was engaged in was what is called speculating in stocks, that is,
buying and selling them, with a view to his own profit, to be made by the excess of the
selling price over the buying price . . . The fact that the bankrupt was engaged in no other
business can not have the effect to make him a merchant or a tradesman, because he
carried on the business he did carry on in the way which he carried it on."
That is, although his business was buying and selling, since this business was simply with
a view to his own profit and not for others, has was not a merchant or tradesman.
Compare In re Surety Guarantee & Trust Co. ([1902], 121 Fed., 73) and In re H.R.
Leighton & Co. ([1906], 147 Fed., 311).
With this background, the Department, in Treasury Decisions 1989, 2005, 2090, and 2135
(not published in Bulletin service), held that the provision of paragraph B of the 1913
Act, allowing as a deduction for the purpose of the normal tax "losses actually sustained
during the year, incurred in trade . . .", did not include losses from isolated transactions;
for instance, in stocks and bonds. In Mente vs. Eisner ([1920], 266 Fed., 161) (certiorari
denied, 254 U.S., 635), these rulings were upheld in a case in which a manufacturer of
bagging was denied deductions for losses in buying and selling cotton on the cotton
exchange for his individual account, not connected with his manufacturing business. (Cf.
Black vs. Bolen [1920], 268 Fed., 427.) Likewise, in L.O. 601 (not published in Bulletin
service), it was held that "losses sustained by a person in buying and selling securities in
his own account, he not being a licensed stock and bond broker buying and selling for
others as well as for himself, are not deductible as losses in trade within the meaning of
paragraph B of the Act of October 3, 1913." The basis of these opinions is thus seen to be
(1) that dealing in securities on one's own account is not technically a "trade"; (2) that

24

isolated transactions in securities, not connected with the tax payer's regular business do
not constitute a "trade."
In the Act of September 8, 1916, the wording of the 1913 Act was slightly changed
(section 5 [a], fourth) to permit a deduction of "losses actually sustained during the year,
incurred in his business or trade . . ." Under this more liberal provision, it has been
uniformly held that where a taxpayer devoted all his time, or the major portion of it, to
buying and selling securities on his own account, this occupation was his "business"; and
therefore he was permitted to deduct losses sustained in such dealings as being "incurred
in his business." A. R. R. 404 (C.B. 4, p. 157); semble L. O.601. These rulings are
inferentially supported by the definitions of trade or business to comprehend "all his
activities for gain, profit, or livelihood, entered into with sufficient frequency, or
occupying such portion of his time or attention as to constitute a vocation," contained in
article 8 of Regulations 41, relative to the war excess-profits tax (approved in Woods vs.
Lewellyn [1921], 289 Fed., 498). . .
It is submitted that these decisions are a sound interpretation of the accepted definition of
business: "Business is a very comprehensive term and embraces everything about which
a person can be employed." Black's Law Dictionary, 158, citing People vs.
Commissioners of Taxes (23 New York, 242, 244). "That which occupies the time,
attention and labor of men for the purpose of a livelihood or profit." Bouvier's Law
Dictionary, Vol. 1, p. 273. Fling vs. Stone Tracy Co. (1910), 220 U. S., 107 at 171; 31
Sup Ct., 342; 55 Law. ed., 389; Ann. Cas. 1912-B, 1312; cited with approval in Von
Baumbach vs. Sargent Land Company (1916), 242 U. S., 503, at 515. If they are sound,
the facts of the instant case require a ruling that the taxpayer was regularly engaged in the
business of buying and selling securities on his own account and was, therefore, entitled
to the benefit of the provisions of section 204(a). (I. T. No. 1818; C. B. II-2, pp. 39-41.)
But, assuming arguendo that the above-quoted opinion may be applied to the present case, it is
evident that the appellant can not be considered as having been engaged in the business of
buying and selling securities within the meaning of section 30 (d) (1) (A) of Act No. 466
According to said opinion, in order that he may so be considered, it is necessary that he must
devote all his time or at least a major portion thereof to said business and that the latter must be
regularly carried on by him.
In the stipulation of facts presented in this case it is agreed that "since the year 1933 up to the
present time, the plaintiff has been continuously engaged in the embroidery business," and that
"in 1935, the plaintiff began engaging in buying and selling mining stocks and securities for his
own exclusive account." There is nothing therein to show that plaintiff and appellant has
regularly devoted all his time or the major portion thereof to the business of buying and selling
mining securities for his own account. On the contrary, it having been stipulated that he has been
continuously engaged in the embroidery business during the same time, it necessarily follows
that he has not and could not have devoted regularly all his time or a major portion thereof to the
buying and selling of mining securities.

25

Furthermore, from Exhibit A attached to the complaint and made a part of said stipulation of
facts, which represents plaintiff's purchases and sales of each class of stocks and securities as
well as the profits and losses resulting therefrom during the year 1939, it appears that he made
purchases and sales of securities only on several days of some months and nothing on others. As
shown in said exhibit, during the month of January, 1939, appellant purchased shares of stock of
different mining corporations on January 2, 3, 4, 6, 13, 19, 20, 25, 30, and sold some of them on
January 4, 10, 13 and 31. During February he made purchases on the dates 1, 8, 13, 14, 25, and
27; and sales on 6, 9, 10, 16, 22, and 30, and sold some on March 9 only. During April he made
two purchases on April 3 and 5, and one sale on April 4. During May he purchased mining shares
of stock on May 9, 10, 13, 19, 24, and 25; and sold some of them on May 9, 10, 12, 13, and 31.
During June appellant made purchases on 1, 3, 5, 8, 13, 15, and 17, and sales on 22, 23, 24, and
28. During July, purchases on 1, 3, 6, 19; and sales on July 24, 25, 26, and 27. During August he
purchased shares of stock on some mining corporations on 5,7, 16, and 18 and sold shares of one
mining corporation on August 10 only. During September appellant did not purchase or sell any
securities. During October he sold securities only on the 12th of said month, and he made no
purchase at all. And during November and December he did not purchase or sell any.
Appellant contends that as from Exhibit A it appears that the mining securities were inventoried
in order to arrive at his profits and losses, they cannot be considered as capital assets, because,
according to section 34, the term capital assets does not include property which would properly
be included in the inventory. But it is to be observed that the law refers not to property merely
included, but to that which would be properly included in the inventory. Section 148 of the
Income Tax Regulations No. 2 of February 10, 1940 (39 Off. Gaz., 325), provides that "the
securities (to be) inventoried as here provided may include only those held for purposes of resale
and not for investment ," and that "the taxpayers who buy and sell or hold securities for
investment or speculation, . . . are not dealers insecurities within the meaning of this rule." And
the General Counsel of the Federal Bureau of Internal Revenue, after quoting Article 105 of
United States Regulations 74 from which said section 148 of our Income Tax Regulations was
taken, said that a person not a dealer in securities is precluded from the use of inventories in
computing his net income."(C. B. X-2, p. 128, G. C. M., 9656.)
The lower court has not therefore erred in dismissing appellant's first cause of action, on the
ground that the losses sustained by appellant from the buying and selling of mining securities are
not losses incurred in business or trade but are capital losses from sales of capital assets, as
contended by appellee.
2. With regard to the second point, the lower court held that, as the new law does not provide that
the personal exemptions shall be allowed in the nature of a deduction from the net income, as
prescribed in the old law, and there is a distinction between exemption and deduction, the tax due
on said exemptions must be deducted from the tax due on the whole net income, instead of
deducting the total amount of the exemptions from the net income.
The argument of the appellee in support of the lower court's decision is that the omission in
section 23 of Act No. 466 of the phrase "in the nature of a deduction" found in section 7 of the
old law, shows that it was the intention of the National Assembly to adopt the innovation
proposed by the Tax Commission which prepared the draft of the new law, an innovation based
26

on what is known as the "Wisconsin Plan" now in operation in several American states. Under
said plan, the cumulative amount of the tax is fixed on any given amount of net income without
regard to the status of the taxpayer, and then this amount is reduced by the tax credit fixed in the
law according to the status of the taxpayer and the number of his dependents as follows: for
single individuals, there is allowed a tax credit of P10; for married persons or heads of family,
P30; and for each dependent below 21 years of age, P10.
Section 7 of the old law provided: "For the purpose of the normal tax only, there shall be allowed
as an exemption in the nature of a deduction from the amount of the net income . . ."; while
section 23 of the new law provides: "For the purpose of the tax provided for in this Title there
shall be allowed the following exemptions." Now, the question to be determined or answered is:
Does this change in the phraseology of the law show the intention of the National Assembly to
change the theory or policy of the old law so as to deduct now the tax on the personal and
additional exemptions from the tax fixed on the amount of the net income, instead of deducting
the amount of personal and additional exemptions from that of the net income, before
determining the tax due on the latter?
It is a well-settled rule of statutory construction that where a statue has been enacted which is
susceptible of several interpretations there is no better means for ascertaining the will and
intention of the legislature than that which is afforded by the history of the statue. Taking into
consideration the history of section 23 of the Commonwealth Act No. 466, the answer to the
above-propounded question must obviously be in the negative. Section 22 of the bill entitled "An
Act to revise, amend and codify the Internal Revenue Laws of the Philippines," prepared by the
Tax Commission and submitted to the National Assembly of the Philippines, in substitution of
section 7 of the old Income Tax Law, reads as follows:
SEC. 22. Amount of tax credit allowable to individuals.There shall be allowed as a
credit in the nature of a deduction from the amount of the tax payable by each citizen or
resident of the Philippines under section 20:
(a) Tax credit of single individuals.The sum of P10 if the person making the return is a
single person or a married person legally separated from his or her spouse.
(b) Tax credit of a married person or head of family.The sum of P30 if the person
making the return is a married man with a wife not legally separated from him, or a
married woman with a husband not legally separated from her, or the head of the family;
Provided, That from the tax due on the aggregate income of both husband and wife when
not legally separated only one tax credit of P30 shall be deducted. For the purpose of this
section, the term "head of a family" includes an unmarried man or a woman with one or
both parents, or one or more brothers or sisters, or one or more legitimate, recognized
natural or adopted children dependent upon him or her for their chief support where such
brothers, sisters, or children are less than twenty-one years of age.
(c) Additional tax credit for dependents.The sum of P10 for each legitimate, recognized
natural, or adopted child wholly dependent upon the taxpayer, if such dependents are
under twenty-one years of age, or incapable of self-support because mentally or
27

physically defective. The additional tax credit under this paragraph shall be allowed only
if the person making the return is the head of the family.
But the National Assembly, instead of adopting or incorporating said proposed section 22 in the
National Internal Revenue Code, C. A. No. 466, copied substantially in section 23 of the latter
provision of section 7 of the old law relating to personal and additional exemptions, with the
only modification that the amount of personal exemption of single individuals has been reduced
from two thousand to one thousand pesos, and that of married persons or heads of family from
four thousand to two thousand five hundred pesos.
If it were the intention of the National Assembly to adopt the "Wisconsin plan" proposed by the
tax Commission, it would have adopted literally, or at least substantially, the provisions of said
section 22 as section 23 of Commonwealth Act No. 466, instead of substantially incorporating
section 7 of the old Income Tax Law as section 23 of the new, except the first paragraph thereof
which reads: "For the purpose of the normal tax only, there shall be allowed as an exemption in
the nature of a deduction from the amount of the net income." This was changed in said section
23, which provides: "For the purpose of the tax provided for in this Title, there shall be allowed
the following exemptions:" From the fact that the National Assembly discarded completely
section 22 of the bill drafted in accordance with the "Wisconsin Plan" and submitted by the Tax
Commission, it is to be presumed that the National Assembly of the Philippines did not intend to
introduce any substantial change in the old law in so far as the effect of personal and additional
exemptions on the income tax is concerned.
The mere fact that the phrase "in the nature of a deduction" found in section 7 of the old law was
omitted in section 23 of the new or National Internal Revenue Code did not and could not effect
any change in the law. It is evident that said phrase was added or inserted in said section 7 only
out of extreme caution, because, even without it, the exemption would have to be deducted from
the gross income in order to determine the net income subject to tax. Had the provision in the old
law been drafted in exactly the same term as that of said section 23, the same construction should
have been adopted. Because "Exception is an immunity or privilege; it is freedom from a charge
or burden to which others are subjected." (Florar vs. Sherifan, 137 Ind., 28; 36 N. E., 365, 369.)
If the amounts of personal and additional exemptions fixed in section 23 are exempt from
taxation, they should not be included as part of the net income, which is taxable. There is nothing
in said section 23 to justify the contention that the tax on personal exemptions (which are exempt
from taxation) should first be fixed, and then deducted from the tax on the net income.
The change of phraseology alone does not lead to the conclusion that it was the intention of the
lawmaker to amend or change the constructions of the old law as contended by the appellee. For
it is a well-established rule, recognized by the Supreme Court of Ohio in the case of Conger vs.
Barker's Adm'r (11 Ohio St., 1); "that in the revision of statutes, neither an alteration in
phraseology nor the omission or addition of words in the latter statute, shall be held, necessarily,
to alter the construction of the former act. And the court is only warranted in holding the
construction of a statute, when revised, to be changed, where the intent of the legislature to make
such change is clear, or the language used in the new act plainly requires such change of
construction. It should be remembered that condensation is a necessity in the work of
compilation or codification. Very frequently words which do not materially affect the sense will
28

be omitted from the statutes as incorporated in the code, or that same general idea will be
expressed in briefer phrases. No design of altering the law itself could rightly be predicated upon
such modifications of the language." (Emphasis ours.) (See Black on the construction and
Interpretation of the Laws, Second Edition, pp. 594, 595.)
Our Income Tax Law is patterned after the United States Revenue or Income Tax Laws. the
United States Revenue Laws of 1916, 1918, 1921, 1924, 1926, 1928 and 1932 considered the
personal and additional exemptions as credits against the net income for the purpose of the
normal tax; and subsequently, the United States Revenue Acts of 1934, 1936 and 1938 amended
the former acts by making said exemptions as credits against the net income for the purpose of
both the normal tax and surtax. Section 7 of our old Income Tax Law, instead of providing that
the personal and additional exemptions shall be allowed as a credit against the net income, as in
the United States Revenue Acts, prescribed that the amounts specified therein shall be allowed as
an exemption in a nature of deduction from the amount of the net income. Which has exactly the
same effect as the provision regarding personal and additional exemptions in the said United
States Revenue Acts. For, as it was explained in the Ways and Means Committee Report No.
764, 73d Congress, 2d Session, pages 6, 23:
To carry out the policy of retaining practically the same tax burden on ordinary income, it
is necessary in connection with the proposed plan to allow the personal exemption and
credits for dependents as an offset against surtax as well as normal tax. The personal
exemption and credits for defendants would appear to be in lieu of deductions for
necessary living expenses. They may well apply to both taxes as do all other ordinary
deductions.
And Paul and Mertens, Law of Federal Taxation, Vol. 3, p. 509, state regarding the change in the
United States Revenue Act of 1934: "The practical effect of this statutory change is to convert
the personal exemption and credit for dependents into deductions . . ." (Emphasis ours.)
The lower court, therefore, erred in not declaring that personal and additional exemptions
claimed by appellant should be credited against or deducted from the net income, and
consequently in not sentencing appellee to refund to appellant the sum of P475.
In view of all the foregoing, the decision of the lower court is affirmed in so far as it dismisses
appellant's first cause of action, and is reversed in so far as it dismissed his second cause of
action. Appellee is sentenced to refund to appellant the sum of P475 claimed in the second cause
of action of the complaint. Without pronouncement as to costs. So ordered.
Moran, C.J., Pablo, Hilado, Bengzon, Briones, and Tuason, JJ., concur.
Separate Opinions
PARAS, J., concurring and dissenting:

29

I concur in the majority opinion in so far as it affirms the dismissal of appellant's first cause of
action, but I dissent from so much thereof as reverses the dismissal of appellant's second cause of
action.
The elimination from section 23 of the National Internal Revenue Code of the words "in the
nature of a deduction from the amount of the net income"(which appeared in section 7 of the old
Income Tax Law), could not have been effected without a purpose; and said purpose certainly is
not to retain the meaning and effect of the suppressed words. If the legislative department did not
intend to make an essential change, the logical and clear way of doing so was to recopy the old
provision. Said elimination was undoubtedly in answer to, and an acceptance of, the innovation
proposed by the Tax Commission, namely, that the amount payable under the present law should
be the difference between the tax due on the entire net income and that due on the exemptions,
thereby doing away with the former practice of allowing the exemptions to be deducted from the
net income and basing the tax on the difference. We cannot say that the failure of the law makers
to incorporate in the new Code the provision regarding tax credits allowable to individuals, as
prepared and submitted by the Tax Commission to the National Assembly in substitution of
section 7 of the old Income Tax Law, suggests a rejection of the new plan and the retention of the
old policy, since the desired aim had equally been accomplished by mere elimination of the
words above referred to. Indeed, at the rates fixed in section 21 of the new Code, the amounts of
personal and additional exemptions granted to individuals under section 23 are exactly the
amounts specified in the provision recommended by the Tax Commission, namely, P10 for single
individuals, P30 for married persons or heads of family, and P10 for each dependent. Section 23
should thus be construed not as an original provision, but as one which is the result of a revision.
The interpretation now pursued by the Government is further consistent with the circumstance
that the tax is levied upon the "entire net income" (section 21), which means "the gross income
computed under section 29, less the deductions allowed by section 30" (section 28). It is
significant that section 30 fails to make any reference to "personal exemptions." The explanation
contained in the Ways and Means Committee Report No. 764, 73rd Congress, 2nd Session, to the
effect that the "personal exemption and credits for dependents would appear to be in lieu of
deductions for necessary living expenses," cannot have controlling force because, in computing
the net income both under the new Code (section 31) and under the old Income Tax Law (section
5), no deduction is allowed in respect of living expenses.
Of course, neither an alteration in phraseology nor the omission or addition of words in a later
statute will necessarily alter the construction of the former act, but, in the present case, the
eliminated words were the very basis for the prior construction. The alternation here is one of
substance, and not merely of form.
Besides, the majority, by their position, are their position, are (unwittingly I hope) playing
favorite to the taxpayers in the upper brackets, a situation which undoubtedly could not have
been intended by the legislators. The following remarks of counsel for the Government are in
point:
Lastly, the action of the appellee Collector, in allowing merely a tax credit upon the
amount of the personal exemptions, gives all taxpayers entitled to the same exemptions,
30

an equal privilege. The tax saving is the same for taxpayers having equal number of the
dependents, whether rich or poor, just as the amount of exemptions remains the same for
all taxpayers under analogous circumstances.
On the contrary, the method advocated by appellant (of deducting the exemption from the
total taxable income) benefits the rich taxpayers, rather than the poor ones. To convince
us of the fact, it is enough to compute the tax on an income lesser than appellant's; say of
P15,000.

Appellant's Method

Net income. . . . . .

Less exemption . . .

Taxable income . . .

Appellees

15,000.00 Net income . . . . . . .

P
15,000.00

3,500.00 Taxable income . . . .

P15,000.00

P11,500.00

Taxed as follows:

Income

Rate

Tax

Income

P2,000.00

Tax

P2,000.00

1%

P20.00

Exempt.

2,000.00

2%

40.00

2,000.00 P 10.00 (1,500

exempt)

2,000.00

3%

60.00

2,000.00

60.00

31

4,000.00

4%

160.00

4,000.00

160.00

1,500.00

5%

75.00

5,000.00

250.00

P11,500.00

P355.00

P15,000.00 P480.00

A comparison of this computation with that of the tax on appellant's income, page 19 of
this brief, reveals that, in appellant's case, the deduction of the exemption results in a
saving of 15 per cent tax on P3,500 (P525) while in the case just discussed, where the
taxpayer's income is much less, the deduction method saves the taxpayer only 5 per cent
tax on P3,500 (P175), because in this case the highest bracket of the taxpayer's income is
only subject to 5 per cent. So that the appellant, with an income of P137,607.09,
economizes by the deduction three times more than the second taxpayer whose income is
merely P15,000. It requires little argument to show that a method of computing taxes
whereby the same exemption results in a higher benefit for the taxpayer with the bigger
income can neither be just nor equitable.
My vote is to affirm the judgment appealed from in toto.
PERFECTO, J., dissenting and concurring:
We dissent from the majority of affirming the decision of the lower court in so far as it dismisses
appellant's first cause of action.
Plaintiff "filed an income tax return for the calendar year 1939 showing that he made a net profit
amounting to P52,449.29 on embroidery business and P17,850 on dividends from various
corporations; and that from the purchase and sales of minings stock and securities he made a
profit of P10,741.30 and incurred losses in the amount of P78,049.10, thereby sustaining a net
loss of P67,307.80. . .
Defendant disallowed the deduction of the loss of P67,307.18, on the theory that the loss was
sustained by plaintiff from the sale of mining stocks and securities which are capital assets and
that the loss arising from the same should be allowed only to the extent of the gain from such
sales.
The question is whether the loss was incurred in trade and business.
"Business" is a very comprehensive term and embraces everything about which a person
can be employed. Black's Law Dictionary, 158, citing People vs. Commissioners of Taxes
(23 New York, 242, 244). "That which occupies the time, attention, and labor of men for
32

the purpose of a livelihood or profit." Bouvier's Law Dictionary, Vol. 1, p. 273. Flint vs.
Stone Tracy co. (1910), 220 U. S., 107 at 171; 31 Sup. Ct., 342; 55 Law. Ed., 389; Ann.
Cas. 1912-B, Law. 1312, cited with approval in Von Baumbach vs. Sargent Land
Company. (1916) 242 U. S., 503 at 515.
We do not have any doubt the plaintiff engaged in the business and trade of buying and selling
mining stocks and securities. We do not see any reason why the losses sustained by him in said
business should be disallowed in the computation for purposes of determining the income tax he
has to pay.
We are of opinion that the lower court's decision should be reversed and that, as to plaintiff's first
cause of action, defendant should be ordered to reimburse the plaintiff the amount of P9,008.14
paid by plaintiff to defendant under protest.
In regards to the second cause of action of plaintiff, we agree with the theory of the majority as
explained in the opinion, but we can not concur in the dispositive part thereof ordering the refund
of the sum of P475, in view of the conclusion we have arrived at regarding plaintiff's first cause
of action, it appearing that plaintiff only prays for the refund of P475 as an alternative in the
event his first cause of action is dismissed.

PADILLA, J., concurring and dissenting:

I dissent from the opinion of the majority on the second cause of action only.
It must be borne in mind that an exemption is neither an exclusion provided for in section 29 (b)
nor a deduction provided for in section 30, C. A. No. 466. Not being a deduction, the amount
constituting an exemption must not be excluded or deducted from the gross or net income.
Exemption means condonation, remission, or, as the trial court aptly calls, waiver of the tax by
the government. The amount of exemption being fixed (section 23, C. A. No. 466), the tax
condoned, remitted or waived must also fixed. The exemption provided for in Income Tax Law is
for personal, living, or family expenses of the taxpayer. It is the same amount regardless of the
amount of net income subject to tax. The law makes no distinction between small and large
incomes. The collector's computation accomplishes the aim of the law, for the tax on the amount
exempted would be the same for every net income, large or small, subject to tax. To illustrate, let
us take the case of two married persons with spouses not legally separated from them and each
with three dependent children, whose net incomes are P10,000 and P30,000, respectively. Under
the Collector's interpretation of the law, the computation would be, as follows:
P10,000.00 net income P30,000.00 net income P2,000.00 1% P20.00 P2,000.00 1% P20.00
2,000.00 2% 40.00 2,000.00 2% 40.00 2,000.00 3% 60.00 2,000.00 3% 60.00 4,000.00 4%
160.00 4,000.00 4% 160.00------------------------------ 10,000.00 5% 500.00P10,000.00 Tax
P220.00 10,000.00 6% 600.00 Exemption P60.00 ---------------------------------- P30,000.00 Tax
P1,320.00 Exemption P60.00.

33

Under appellant's interpretation of the law, the computation would be, as follows:.
P10,000.00 net income P30,000.00 net income 4,000.00 less exemption 4,000.00 less
exemption---------- ---------- P6,000.00 taxable net P26,000.00 taxable net P2,000.00 1% P20.00
P2,000.00 1% P20.00 2,000.00 2% 40.00 2,000.00 2% 40.00 2,000.00 3% 60.00 2,000.00 3%
60.00------------------------------ 4,000.00 4% 160.00 P6,000.00 Tax P120.00 10,000.00 5% 500.00
6,000.00 6% 360.00 -------------------------------- P26,000.00 Tax P1,140.00.
or under appellant's other interpretation of the law, the computation would be, as follows:
P2,000.00 1% P20.00 P2,000.00 1% P20.00 2,000.00 2% 40.00 2,000.00 2% 40.00 2,000.00 3%
60.00 2,000.00 3% 60.00 4,000.00 4% 160.00 4,000.00 4% 160.00-------------------------------10,000.00 5% 500.00P10,000.00 Tax P120.00 6,000.00 6% 360.00 Exemption P160.00 4,000.00
6% 240.00 --------------------------------------- P26,000.00 Tax P1,140.00 Exemption P240.00.
The result under appellant's computation is that a large net income would enjoy a bigger amount
of tax exemption than a small net income, when the law is clear that such exemption is of fixed
amount regardless of the amount of net income subject to tax.
It is not correct to say that the "Wisconsin Plan" referred to in the majority opinion was not
adopted. It was adopted not in form but in substance.
I am of the opinion that the judgment under review should be affirmed.

34

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. 48231

p June 30, 1947

WISE & CO., INC., ET AL., plaintiffs-appellants,

vs.
BIBIANO L. MEER, Collector of Internal Revenue, defendant-appellee.
Ross, Selph, Carrascoso and Janda for appellants.
Office of the Solicitor General for appellee.
HILADO, J.:
This is an appeal by Wise & Co., Inc. and its co-plaintiff from the judgment of the Court of First
Instance of Manila in civil case No. 56200 of said court, absolving the defendant Collector of
Internal Revenue from the complaint without costs. The complaint was for recovery of certain
amounts therein specified, which had been paid by said plaintiffs under written protest to said
defendant, who had previously assessed said amounts against the respective plaintiffs by way of
deficiency income taxes for the year 1937, as detailed under paragraph 6 of defendant's special
defense (Record of Appeal, pp. 7-10). Appellants made eight assignments of error, to wit:
The trial court erred in finding:
I. That the Manila Wine Merchants, Ltd., a Hongkong corporation, was in liquidation
beginning June 1, 1937, and that all dividends declared and paid thereafter were
distributions of all its assets in complete liquidation.
II. That all distributions made by the Hongkong corporation after June 1, 1937, were
subject to both normal tax and surtax.
III. That income received by one corporation from another was taxable under the Income
Tax Law, and that Wise & Co., Inc., was taxable on the distribution of its share of the
same net profits on which the Hongkong Company had already paid Philippine tax,
despite the clear provisions of section 10 of the Income Tax Law then in effect.
IV. That the non-resident individual stockholder appellants were subject to both normal
and additional tax on the distributions received despite the clear provisions of section 5
(b) of the Income Tax Law then in effect.
35

V. That section 25 (a) of the Income Tax Law makes distributions in liquidation of a
foreign corporation, dissolution proceedings of which were conducted in a foreign
country, taxable income to a non-resident individual stockholder.
VI. That section 199 of the Income Tax regulations, providing that in a distribution by a
corporation in complete liquidation of its assets the gain realized by a stockholder,
whether individual or corporate, is taxable as a dividend, is ineffective.
VII. That the deficiency assessment was properly collected.
VIII. That the refunds claimed by plaintiffs were not in order, and in rendering judgment
absolving the Collector of Internal Revenue from making such refunds.
The facts have been stipulated in writing, as quoted verbatim in the decision of the trial court
thus:
I
That the allegations of paragraphs I and II of the complaint are true and correct.
II
That during the year 1937, plaintiffs, except Mr. E.M.G. Strickland (who, as husband of
the plaintiff Mrs. E.M.G. Strickland, is only a nominal party herein), were stockholders
of Manila Wine Merchants, Ltd., a foreign corporation duly authorized to do business in
the Philippines.
III
That on May 27, 1937, the Board of Directors of Manila Wine Merchants, Ltd.,
(hereinafter referred to as the Hongkong Company), recommended to the stockholders of
the company that they adopt the resolutions necessary to enable the company to sell its
business and assets to Manila Wine Merchants, Inc., a Philippine corporation formed on
May 27, 1937, (hereinafter referred to as the Manila Company), for the sum of P400,000
Philippine currency; that this sale was duly authorized by the stockholders of the
Hongkong Company at a meeting held on July 22, 1937; that the contract of sale between
the two companies was executed on the same date, a copy of the contract being attached
hereto as Schedule "A"; and that the final resolutions completing the said sale and
transferring the business and assets of the Hongkong Company to the Manila Company
were adopted on August 3, 1937, on which date the Manila Company were adopted on
August 3, 1937, on which date the Manila Company paid the Hongkong company the
P400,000 purchase price.
IV

36

That pursuant to a resolution by its Board of Directors purporting to declare a dividend,

the Hongkong Company made a distribution from its earnings for the year 1937 to its
stockholders, plaintiffs receiving the following:

Declared and paid

June 8, 1937

Wise & Co.,

Inc.

P7,677.82

Mr. J.F.
MacGregor

2,554.86

Mr. N.C.
MacGregor

2,369.48

Mr. C.J.
Lafrentz

529.51

Mrs. E.M.G.
Strickland

2,369.48

Mrs. M.J.G.
Mullins

2,369.48

P17,870.63

That the Hongkong Company has paid Philippine income tax on the entire earnings from
which the said distributions were paid.
V
37

That after deducting the said dividend of June 8, 1937, the surplus of the Hongkong
Company resulting from the active conduct of its business was P74,182.12. That as a
result of the sale of its business and assets to the Manila Company, the surplus of the
Hongkong Company was increased to a total of P270,116.59.
That pursuant to resolutions of its Board of Directors, and of its shareholders, purporting
to declare dividends, copies of which are attached hereto as Schedules "B" and "B-1", the
Hongkong Company distributed this surplus to its stockholders, plaintiffs receiving the
following sums on the following dates:
Declared
July 22,
1937
Paid
August 4,
1937

Wise & Co., Inc.

Declared
July 22,
1937
Paid
October 28,
1937

P113,851.85 P 2,198.24

Mr. J.F. MacGregor

37,885.20

731.48

Mr. N.C. MacGregor

35,137.03

678.42

7,851.86

151.61

Mrs. E.M.G. Strickland

35,137.03

678.42

Mrs. M.J.G. Mullins

35,137.03

678.42

Mr. C.J. Lafrentz

P265,000.00 P 5,116.59
That Philippine income tax had been paid by the Hongkong Company on the said surplus
from which the said distributions were made.
VI
38

That on August 19, 1937, at a special general meeting of the shareholders of the
Hongkong Company, the stockholders by proper resolution directed that the company be
voluntarily liquidated and its capital distributed among the stockholders; that the
stockholders at such meeting appointed a liquidator duly paid off the remaining debts of
the Hongkong Company and distributed its capital among the stockholders including
plaintiffs; that the liquidator duly filed his accounting on January 12, 1938, and in
accordance with the provisions of Hongkong Law, the Hongkong Company was duly
dissolved at the expiration of three moths from that date.
VII
That plaintiffs duly filed Philippine income tax returns. That defendant subsequently
made the following deficiency assessments against plaintiffs:
WISE & COMPANY, INC.

Net income as per return

P87,649.67

Add: Deductions disallowed Loss on

shares of
pstock in the Manila Wine
Merchants, Ltd.
presulting from the liquidation of
said firm

Income not declared:

Return of capital
Share of surplus

44,515.00

P51,185.00
123,727.88

Total liquidating dividends

received
P174,912.88
Less value of shares as per books
95,700.00

Profits realized on shares of stock

P79,212.88

in the
Manila Wine Merchants Ltd.
resulting
from the liquidation of the said

39

firm

Accrued income tax as per return

5,258.98

Total

P216,636.53

Deduct accrued income tax

12,262.45

Net income as per investigation

204,374.08

6 per cent Normal tax

12,262.45

Less amount already paid

6,307.92

Balance still due and collectible

7,003.47

J. F. MACGREGOR

Net income as per return

P47,479.44

Deduct: Ordinary dividends

Net income as per investigation subject

to
normal tax:
Return of capital
Share of surplus

6,307.92

P17,032,25
41,171.52

40

Total liquidating dividends

received

Less cost of shares

P58,203.77

17,032.25

Profit realized on shares of stock

in the Manila Wine Merchants.,
Ltd.
Resulting from the liquidation of
said firm

Normal tax at 3 per cent

Additional tax due

P41,171.52

1,235.15

549.59

Total normal and additional taxes

Less: Amount already paid

Balance still due and collectible

1,784.74

549.59

1,235.15

N. C. MACGREGOR

Net income as per return

Deduct: Ordinary dividends

P44,177.06

5,992.11

Net income as per investigation subject

to
normal tax:

41

Return of capital
Share of surplus

P15,796.75
38,184.95

Total liquidating dividends

received.
Less cost of shares

P53,981.70
15,796.75

Profit realized on shares of stock

in the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

Normal tax at 3 per cent

P38,184.95

1,145.55

Additional tax due

483.54

Total normal and additional taxes

Less amount already paid

Balance still due and collectible

1,629.09

483.55

1,145.54

C. J. LAFRENTZ

Net income as per return

Deduct: Ordinary dividends

P9,778.18

1,245.20

Net income as per investigation subject

to
42

normal tax:

Return of capital
Share of surplus

Total liquidating dividends

received
Less cost of shares

P3,530.00
8,532.98

P12,062.98
3,530.00

Profit realized on shares of stock

in the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

P8,532.98

3 per cent normal tax due and

collectible

255.99

MRS. E. M. G. STRICKLAND

Net income as per return

P44,057.06

Deduct: Ordinary dividends

5,872.11

Net income as per investigation subject

to
normal tax:

Return of capital
Share of surplus

P15,796.75
38,184.95

43

Total liquidating dividends

received
Less cost of shares

P53,981.70
15,796.75

Profit realized on shares of stock

in the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

P38,184.95

Normal tax at 3 per cent

1,145.55

Additional tax due

481.14

Total normal and additional taxes

1,626.69

Balance still due and collectible

1,145.54

MRS. M. J. G. MULLINS

Net income per return

P44,057.06

Deduct: Ordinary dividends

5,872.11

Net income as per investigation subject

to
normal tax:

Return of capital
Share of surplus

P15,796.75
38,184.95

44

Total liquidating dividends

received
Less cost of shares

P53,981.70
15,796.75

Profit realized on shares of stock

in the
Manila Wine Merchants, Ltd.
Resulting
from the liquidation of the said
firm

Normal tax at 3 per cent

P38,184.95

1,145.55

Additional tax due

481.14

Total normal and additional taxes

Less amount already paid

1,626.69

481.15

Balance still due and collectible

P1,145.54

VIII
That said plaintiffs duly paid the said amounts demanded by defendant under written
protest, which was overruled in due course; that the plaintiffs have since July 1, 1939
requested from defendant a refund of the said amounts which defendant has refused and
still refuses to refund.
IX
That this stipulation is equally the work of both parties and shall be fairly interpreted to
give effect to their intention that this case shall be decided solely upon points of law.
X
The parties incorporate the Corporation Law and Companies Act of Hongkong and the
applicable decisions made thereunder, into this stipulation by reference, and either party
45

may at any stage in the proceedings in this case cite applicable sections of the law and the
authorities decided thereunder as though the same had been duly proved in evidence.
XI
That the parties hereto reserve the right to submit other and further evidence at the trial of
this case. (Record on Appeal, pp. 19-26.)
1. The first assignment of error. Appellants maintain that the amounts received by them and
on which the taxes in question were assessed and collected were ordinary dividends; while upon
the other hand, appellee contends that they were liquidating dividends. If the first proposition is
correct, this assignment would be well-taken, otherwise, the decision of the court upon the point
must be upheld.
It appears that on May 27, 1937, the Board of Directors of the Manila Wine Merchants, Ltd.
(hereafter called the Hongkong Co.), recommended to the stockholders of said company "that the
Company should be wound up voluntarily by the members and the business sold as a going
concern to a new company incorporated under the laws of the Philippine Islands under the style
of "The Manila Wine Merchants, Inc." (Annex A defendant's answer, Record on Appeal, p. 12),
and that they adopt the resolutions necessary to enable the company to sell its business and assets
to said new company (hereafter called the Manila Company), organized on that same date, for
the price of P400,000, Philippine currency; that the sale was duly authorized by the stockholders
of the Hongkong Co. at a meeting held on July 22, 1937; and that the contract of sale between
the two companies was executed on the same day, as appears from the copy of the contract,
Schedule A of the Stipulation of Facts (par. III, Stipulation of Facts, Record on Appeal, pp. 1920). It will be noted that the Board of Directors of the Hongkong Co., in recommending the sale,
specifically mentioned "a new Company incorporated under the laws of the Philippine Islands
under the style of "The Manila Wine Merchants, Inc." as the purchaser, which fact shows that at
the time of the recommendation the Manila Company had already been formed, although on the
very same day; and this and the further fact that it was really the latter corporation that became
the purchaser should clearly point to the conclusion that the Manila Company was organized for
the express purpose of succeeding the Hongkong Co. The stipulated facts would admit of no
saner interpretation.
While it is true that the contract of sale was signed on July 22, 1937, it contains in its paragraph 4
of the express provision that the transfer "will take effect as on and from the first day of June,
One thousand nine hundred and thirty-seven, and until completion thereof, the Company shall
stand possessed of the property hereby agreed to be transferred and shall carry on its business in
trust for the Corporation" (Schedule A of Stipulation of Facts, Record on Appeal, p. 15). "The
Company" was the Hongkong Company and "the Corporation" was the Manila Company. For
"the Company" to carry on business in trust for the "Corporation," it was necessary for the latter
to be the owner of the business. It is plain that the parties considered the sale as made as on and
from June 1, 1937 for the purposes of said sale and transfer, both parties agreed that the deed
of July 22, 1937, was to retroact to the first day of the preceding month.

46

The cited provision could not have served any other purpose than to consider the sale as made as
of June 1, 1937. If it had not been for this purpose, if the intention had been that the sale was to
be effective upon the date of the written contract or subsequently, said provision would certainly
never have been written, for how could the transfer or sale take effect as of June 1, 1937, if it
were to be considered as made at a later date?
The first distribution made after June 1, 1937, of what plaintiffs call ordinary dividends but what
defendant denominates liquidating dividends was declared and paid on June 8, 1937 (Stipulation,
Paragraph IV, Record on Appeal, p. 20). It will be recalled that the recommendation of the Board
of Directors of the Hongkong Company, at their meeting on May 27, 1937, was first of all "that
the company should be wound up voluntarily by the members"(Record on Appeal, p.12), and in
pursuance of that purpose, it was further recommended that the Company's business be sold as a
going concern to the Manila Company (ibid). Complying with the Companies Ordinance 1932
for companies registered in Hongkong for the voluntary winding up by members, a Declaration
of Solvency was drawn up duly signed before the British Consul-General in Manila by the same
directors, and said declaration was returned to Hongkong for filing with the Registrar of
Companies (ibid.) Both recommendations were in due course approved and ratified. The later
execution of the formal deed of sale and the successive distributions of the amounts in question
among the stockholders of the Hongkong Company were obviously other steps in its complete
liquidation. And they leave no room for doubt in the mind of the court that said distributions
were not in the ordinary course of business and with intent to maintain the corporation as a going
concern in which case they would have been distributions of ordinary dividends but after
the liquidation of the business had been decided upon, which makes them payments for the
surrender and relinquishment of the stockholders' interest in the corporation, or so-called
liquidating dividends.
More than with the distribution of June 8, 1937, is this true with those declared on July 22, 1937,
and paid on August 4 and October 28, 1937, respectively (Stipulation of Facts, par. 5, Record on
Appeal, p. 21). The distributions thus declared on July 22, 1937, and paid on August 4 and
October 28, 1937, were from the surplus of the Hongkong Company resulting from the active
conduct of its business and amounting to P74,182.12, which surplus was augmented to a total of
P270,116.59 as a result of the sale of its business and assets to the Manila Company (ibid.). In
both Schedules B and B-1 of the Stipulation of Facts (Record on appeal, pp. 16-18), being
minutes of directors' meetings of the Hongkong Co., where authorization and instruction were
given to declare and pay in the form of "dividends" to the shareholders the amounts in question,
it was specifically provided that the surplus to be so distributed be that resulting after providing
for return of capital and necessary or various expenses, as shown in the balance sheet prepared
as of June 1, 1937, and in the reconstructed balance sheet of the same date presented by the
company's auditors, it having been resolved in Schedule B-1 that "any balance remaining to be
distributed when final liquidator's account has been rendered and paid" (Record on Appeal, p. 18;
emphasis supplied). It thus becomes more evident that those distributions were to be made in the
course or as a result of the Hongkong Company's liquidation and that said liquidation was to be
complete and final. And although the various resolutions above-mentioned speak of distributions
of dividends when referring to those already alluded to, "a distribution does not necessarily
become a dividend by reason of the fact that it is called a dividend by the distributing
corporation." (Holmes Federal Taxes, 6th edition, 774.)
47

The ordinary connotation of liquidating dividend involves the distribution of assets by a

corporation to its stockholders upon dissolution. (Klein, Federal Income Taxation, 253254.)
But it is contended by plaintiffs that as of August 4, 1937, the Hongkong Company "had taken no
steps toward dissolution or liquidation and still retained on hand liquid assets in excess of its
capitalization." They also assert that it was only on August 19, 1937, that said company took the
first corporate steps toward liquidation (Appellant's Brief, pp. 9-10). The fact, however, is that
since July 22, 1937, when the formal deed of sale of all the properties, assets, and business of the
Hongkong Company to the Manila Company was made, it was expressly stipulated that the sale
or transfer shall take effect as of June 1, 1937. As already indicated, the transfer of what was
sold, like the sale itself, was, by the mutual agreement of the parties, considered as made on and
from that date, and that, if thereafter and until final completion of the transfer, the Hongkong
Company continued to run the business, it did so in trust for the new owner, the Manila
Company. In the case of Canal-Commercial T. & S. Bk. vs. Comm'r (63 Fed. [2d], 619, 620) it
was held that:
. . . The determining element therefore is whether the distribution was in the ordinary
course of business and with intent to maintain the corporation as a going concern, or after
deciding to quit with intent to liquidate the business. Proceedings actually begun to
dissolve the corporation or formal action taken to liquidate it are but evidentiary and not
indispensable. Tootle vs. Commissioner (C.C.A. 58 F. [2d, 576.) The fact that the
distribution is wholly from surplus and not from capital, and therefore lawful as a
dividend is only evidence. In Hellmich vs. Hellman, and Tootle vs. Commissioner, supra,
the distribution was wholly from profits yet held to be one in liquidation . . . (Emphasis
Supplied.)
In the case at bar, when in the deed of July 22, 1937, by authority of its stockholders, the
Hongkong Company thru its authorized representative declared and agreed that the aforesaid sale
and transfer shall take effect as of June 1, 1937, and distribution from its assets to those same
stockholders made after June 1, 1937, altho before July 22, 1937, must have been considered by
them as liquidating dividends; for how could they consistently deem all the business and assets
of the corporation sold as of June 1, 1937, and still say that said corporation, as a going concern,
distributed ordinary dividends to them thereafter?
In Holmby Corporation vs. Comm'r (83 Fed. [2d], 548-550), the court said:
. . . the fact that the distributions were called "dividends" and were made, in part, from
earnings and profits, and that some of them were made before liquidation or dissolution
proceedings were commenced, is not controlling. . . . The determining element is whether
the distributions were in the ordinary course of business and with intent to maintain the
corporation as a going concern, or after deciding to quit and with intent to liquidate the
business . . .. (Emphasis supplied.)

48

The directors or representatives of the Hongkong Company or the Manila Company, or both,
could of course not convert into ordinary dividends what in law and in reality were not such. As
aptly stated by Chief Justice Shaw in Comm. vs. Hunt (38 Am. Dec., 354-355),
The law is not to be hoodwinked by colorable pretenses. It looks at truth and reality
through whatever disguise they may assume.
The amounts thus distributed among the plaintiffs were not in the nature of a recurring return on
stock in fact, they surrendered and relinquished their stock in return for said distributions,
thus ceasing to be stockholders of the Hongkong Company, which in turn ceased to exist in its
own right as a going concern during its more or less brief administration of the business as
trustee for the Manila Company, and finally disappeared even as such trustee.
The distinction between a distribution in liquidation and an ordinary dividend is factual;
the result in each case depending on the particular circumstances of the case and the
intent of the parties. If the distribution is in the nature of a recurring return on stock it is
an ordinary dividend. However, if the corporation is really winding up its business or
recapitalizing and narrowing its activities, the distribution may properly be treated as in
complete or partial liquidation and as payment by the corporation to the stockholder for
his stock. The corporation is, in the latter instances, wiping out all parts of the
stockholders' interest in the company . . .. (Montgomery, Federal Income Tax Handbook
[1938-1939], 258; emphasis supplied.)
It is our considered opinion that we are not dealing here with "the legal right of a taxpayer to
decrease the amount of what otherwise will be his taxes, or altogether avoid them, by means
which the law permits" (St. Louis Union Co. vs. U.S., 82 Fed. [2d], 61), but with a situation
where we have to apply in favor of the government the principle that the "liability for taxes
cannot be evaded by a transaction constituting a colorable subterfuge" (61 C.J., 173), it being
clear that the distributions under consideration were not ordinary dividends and were taxable in
the manner, form and amounts decreed by the court below.
2. The second assignment of error. In disposing of the first assignment of error, we held that
the distributions in the instant case were not ordinary dividends but payments for surrendered or
relinquished stock in a corporation in complete liquidation, sometimes called liquidating
dividends. The question is whether such amounts were taxable income. The Income Tax Law,
Act No. 2833 section 25 (a), as amended by section 4 of Act. No. 3761, inter alia stipulated:
Where a corporation, partnership, association, joint-account, or insurance company
distributes all of its assets in complete liquidation or dissolution, the gain realized or loss
sustained by the stockholder, whether individual or corporation, is a taxable income or a
deductible loss as the case may be. (Emphasis supplied.)
Partial source of the foregoing provision was section 201 (c) of the U.S. Revenue Act of 1918,
approved February 24, 1919, providing:

49

Amounts distributed in the liquidation of a corporation shall be treated as payments in

exchange for the stock or share, and any gain or profit realized thereby shall be taxed to
the distributee as other gains or profits.
It is a familiar rule of statutory construction that the judicial construction attached to the sources
of statutes adopted in a jurisdiction are of authoritative value in the interpretation of such local
laws. The Supreme Court of the United States has had occasion to construe certain pertinent
parts of the Federal Revenue Act above-mentioned on February 20, 1928, when it decided the
case of Hellmich vs. Hellman (276 U.S., 233; 72 Law. ed., 544). The case involved the recovery
of additional income taxes assessed against the plaintiffs under protest. And its determination
hinged around the construction of parts of said act after which those of our own law now under
discussion were patterned. Justice Sanford said:
The question here is whether the gains realized by stockholders from the amounts
distributed in the liquidation of the assets of a dissolved corporation, out of its earnings or
profits accumulated since February 28, 1913, were taxable to them as other "gains or
profits", or whether the amounts so distributed were "dividends" exempt from the normal
tax.
Section 201 (a) of the act defined the term "dividend" as "any distribution made by a
corporation . . . to its shareholders . . . whether in cash or in other property .. out of its
earnings or profits accumulated since February 28, 1913 . . .." Section 201 (c) provided
that "amounts distributed in the liquidation of a corporation shall be treated as payments
in exchange for stock or shares, and any gain or profit realized thereby shall be taxed to
the distributee as other gains or profits."
Our law at the time of the transactions in question, in providing that where a corporation, etc.
distributes all its assets in complete liquidation or dissolution, the gain realized or loss sustained
by the stockholder is a taxable income or a deductible loss as the case may be, in effect treated
such distributions as payments in exchange for the stock or share. Thus, in making the deficiency
assessments under consideration, the Collector, among other items, made proper deduction of the
"value of shares" or "cost of shares" in the case of each individual plaintiff, assessing the tax only
on the resulting "profit realized" (Stipulation, par. VII, Record on Appeal, pp. 22-25); and of
course in case the value or cost of the shares should exceed the distribution received by the
stockholder, the resulting difference will be treated as a "deductible loss."
In the same case the Supreme Court of the United States made the following quotation, which is
here relevant, from Treasury Regulations 45, article 1548:
. . . So-called liquidation or dissolution dividends are not dividends within the meaning of
the statute, and amounts so distributed, whether or not including any surplus earned since
February 28, 1913, are to be regarded as payments for the stock of the dissolved
corporation. Any excess so received over the cost of his stock to the stockholder, or over
its fair market value as of March 1, 1913, if acquired prior thereto, is a taxable profit. A
distribution in liquidation of the assets and business of a corporation, which is a return to
the stockholders of the value of his stock upon a surrender of his interest in the
50

corporation, is distinguishable from a dividend paid by a going corporation out of current

earnings or accumulated surplus when declared by the directors in their discretion, which
is in the nature of a recurrent return upon the stock. (72 Law. ed., 546.)
The Income Tax Law of the Philippines in force at the time defined the term "dividend" in
section 25 (a), as amended, as "any distribution made by a corporation . . . out of its earnings or
profits accumulated since March 1, 1913, and payable to its shareholders whether in cash or
other property." This definition is substantially the same as that given to the same term by the
U.S. Revenue Act of 1918 quoted by Justice Sanford in the passage above inserted.
Plaintiffs contend that defendant's position would result in double taxation. A similar contention
has been adversely disposed of against the taxpayer in the Hellmich case in these words:
The gains realized by the stockholders from the distribution of the assets in liquidation
were subject to the normal tax in like manner as if they had sold their stock to third
persons. The objection that this results in double taxation of the accumulated earnings
and profits is no more available in the one case than it would have been in the other. See
Merchants' Loan & T. Co. vs. Smietanki, 255 U.S., 509; 65 Law. ed., 751; 15 A.L.R.,
1305; 41 Sup. Ct. Rep., 386; Goodrich vs. Edwards, 255 U.S. 527; 65 Law. ed., 758; 41
Sup. Ct. Rep., 390. When, as here, Congress clearly expressed its intention, the statute
must be sustained even though double taxation results. See Patton vs. Brady , 184 U.S.,
608; 46 Law ed., 713; 22 Sup. Ct. Rep., 493; Cream of Wheat Co. vs. Grand Forks
County, 253 U.S., 325, 330; 64 Law. ed., 931, 934; 40 Sup. Ct. Rep., 558. (Hellmich vs.
Hellman, supra; 72 Law. ed., 547.)
It should be borne in mind that plaintiffs received the distributions in question in exchange for
the surrender and relinquishment by them of their stock in the Hongkong Company which was
dissolved and in process of complete liquidation. That money in the hands of the corporation
formed a part of its income and was properly taxable to it under the then existing Income Tax
Law. When the corporation was dissolved and in process of complete liquidation and its
shareholders surrendered their stock to it and it paid the sums in question to them in exchange, a
transaction took place, which was no different in its essence from a sale of the same stock to a
third party who paid therefor. In either case the shareholder who received the consideration for
the stock earned that much money as income of his own, which again was properly taxable to
him under the same Income Tax Law. In the case of the sale to a third person, it is not perceived
how the objection of double taxation could have been successfully raised. Neither can we
conceive how it could be available where, as in this case, the stock was transferred back to the
dissolved corporation.
3. The third assignment of error. In view of what has been said in our consideration of the
second assignment of error, the third can be briefly disposed of. Having held that the
distributions involved herein were not ordinary dividends but payments for stock surrendered
and relinquished by the shareholders to the dissolved corporation, or so-called liquidating
dividends, we have the road clear to declaring that under section 25 (a) of the former Income Tax
Law, as amended, said distributions were taxable alike to Wise and Co., Inc. and to the other
plaintiffs. We hold that both the proviso of section 10 (a) of said Income Tax Law and section
51

198 of Regulations No. 81 refer to ordinary dividends, not to distributions made in complete
liquidation or dissolution of a corporation which result in the realization of a gain as specifically
contemplated in section 25 (a) of the same law, as amended, which as aforesaid expressly
provides for the taxability of such gain as income, whether the stockholder happens to be an
individual or a corporation. By analogy, we can cite the following additional passages from the
Hellmich case:
The controlling question is whether the amounts distributed to the stockholders out of the
earnings and profits accumulated by the corporation since February 28, 1913, were to be
treated under section 201 (a) as "dividends," which were exempt from the normal tax; or
under section 201 (c) as payments made by the corporation in exchange for its stock,
which were taxable "as other gains or profits.
It is true that if section 201 (a) stood alone its broad definition of the term "dividend" would
apparently include distributions made to stockholders in the liquidation of a corporation
although this term, as generally understood and used, refers to the recurrent return upon stock
paid to stockholders by a going corporation in the ordinary course of business, which does not
reduce their stockholdings and leaves them in a position to enjoy future returns upon the same
stock. (See Lynch vs. Hornby, 247 U.S., 339, 344-346; and Langstaff vs. Lucas [D. C.], 9 Fed.
[2d], 691, 694.)
However, when section 201 (a) and section 201 (c) are read together, under the longestablished rule that the intention of the lawmakers is to be deduced from a view of every
material part of the statute (Kohlsaat vs. Murphy, 96 U.S., 153, 159; 24 Law. ed., 846),
we think it clear that the general definition of a dividend in section 201 (a) was not
intended to apply to distributions made to stockholders in the liquidation of a
corporation, but that it was intended that such distributions should be governed by
section 201 (c), which, dealing specifically with such liquidation, provided that the
amounts distributed should "be treated as payments in exchange for stock," and that any
gain realized thereby should be taxed to the stockholders "as other gains or profits." This
brings the two sections into entire harmony and gives to each its natural meaning and
due effect. . . . (Hellmich vs. Hellman, supra; emphasis supplied.)
4. The fourth assignment of error. Under this assignment it is contended by the non-resident
individual stockholder appellants that they were not subject to the normal tax as regards the
distributions received by them and involved in the instant case. They "reported these
distributions as dividends from profits on which Philippine income tax had been paid . . .."
(Appellants' brief, p. 21.) They assert that the distributions were subject only to the additional
tax; whereas the Collector contends that they were subject to both the normal and the additional
tax. After what has been said above, it hardly needs stating that the manner and form of reporting
these distributions employed by said appellants could not, under the Law, change their real
nature as payments for surrendered stock, or so-called liquidating dividends, provided for in
section 25 (a) of the then Income Tax Law. Such distributions under the law were subject to both
the normal and the additional tax provided for.

52

. . . Loosely speaking, the distribution to the stockholders of a corporation's assets, upon

liquidation, might be termed a dividend; but this is not what is generally meant and
understood by that word. As generally understood and used, a dividend is a return upon
the stock of its stockholders, paid to them by a going corporation without reducing their
stockholdings, leaving them in a position to enjoy future returns upon the same stock . . ..
In other words, it is earnings paid to him by the corporation upon his invested capital
therein, without wiping out his capital. On the other hand, when a solvent corporation
dissolves and liquidates, it distributes to its stockholders not only any earnings it may
have on hand, but it also pays to them their invested capital, namely, the amount which
they had paid in for their stocks, thus wiping out their interest in the company . . ..
(Langstaff vs. Lucas, 9 Fed. [2d], 691, 694.)
5. The fifth assignment of error. This assignment is made in behalf of those appellants who
were non-resident alien individuals, and for them it is in effect said that if the distributions
received by them were to be considered as a sale of their stock to the Hongkong Company, the
profit realized by them does not constitute income from Philippine sources and is not subject to
Philippine taxes, "since all steps in the carrying out of this so-called sale took place outside the
Philippines." (Appellants' brief, p. 26.) We do not think this contention is tenable under the facts
and circumstances of record. The Hongkong Company was at the time of the sale of its business
in the Philippines, and the Manila Company was a domestic corporation domiciled and doing
business also in the Philippines. Schedule A of the Stipulation of Facts (Record on Appeal, p. 13)
declares, among other things, that the Hongkong Company was incorporated for the purpose of
carrying on in the Philippine Islands the business of wine, beer, and spirit merchants and the
other objects set out in its memorandum of association. Hence, its earnings, profits, and assets,
including those from whose proceeds the distributions in question were made, the major part of
which consisted in the purchase price of the business, had been earned and acquired in the
Philippines. From aught that appears in the record it is clear that said distributions were income
"from Philippine sources."
6. The sixth assignment of error. Section 199 of Regulations No. 81, deleting immaterial parts,
reads:
SEC. 199. Distributions in liquidation. In all cases where a corporation . . . distributes
all of its property or assets in complete liquidation or dissolution, the gain realized from
the transaction by the stockholder . . . is taxable as a dividend to the extent that it is paid
out of earnings or profits of the corporation . . .. If the amount received by the
stockholder in liquidation is less than the cost or other basis of the stock, a deductible loss
is sustained.
This regulation would seem to support the contention that the distributions in question, at least
those proceeding from sources other than the earnings or profits of the dissolved corporation,
were not taxable. Placing the above-quoted section of Regulations No. 81 side by side with
section 25 (a) of the amended Income Tax Law then in force, we notice that while the regulation
limits the taxability of the gain realized by the stockholder "to the extent that it is paid out of
earnings or profits of the corporation, "section 25 (a) of the law, far from so limiting its
taxability, provides that the gain thus realized, is a "taxable income" under the law so long as
53

a gain is realized, it will be taxable income whether the distribution comes from the earnings or
profits of the corporation or from the sale of all of its assets in general, so long as the distribution
is made "in complete liquidation or dissolution". The regulation makes the gain taxable as a
dividend, while the law makes it a taxable income. An inevitable conflict between the two
provisions seems to exist, and in such a case, of course, the law prevails.
Treasury Department cannot impose or exempt from income taxes, and regulations
purporting to exempt from taxation income specifically taxes would be void.
xxx

xxx

xxx

Any erroneous interpretation of revenue act by regulation of Treasury Department would

not estop government from asserting tax on income, though taxpayer had been misled by
such interpretation, and by it induced to expose property to taxation. (Langstaff vs. Lucas,
9 Fed. [2d], 691.)
7 and 8. The seventh and eight assignments of error. In view of what has been said above,
these two assignments need no separate treatment.
For the foregoing consideration, the judgment appealed from will be affirmed with the costs of
both instances against the appellants. So ordered.
Moran, C.J., Paras, Feria, Pablo, Perfecto, Bengzon, Briones, Hontiveros, Padilla, and Tuason,
JJ., concur.

RESOLUTION ON MOTION FOR RECONSIDERATION

July 28, 1947
HILADO, J.:
Plaintiffs and appellants have filed a motion for reconsideration dated July 10, 1947. After
carefully considering said motion, which makes particular reference to appellants' fifth
assignment of error, the Court does not consider the arguments therein adduced tenable. Stripped
to their bare essentials, the movants' contentions are summarized in the following propositions
found on pages 3-4 of their motto, to wit:
Since appellants J.F. MacGregor, N.C. MacGregor, C.J. Lafrentz, E.M.G. Strickland, and
Mrs. M.J.G. Mullins were all non-resident aliens and since the court has held that the
transaction in this case amounted to a sale or exchange of their shares in a foreign
corporation, which sale or exchange took place entirely outside of the Philippine Islands,
it follows that they have not derived income from the Philippine sources and are not
subject to the taxes which have been collected from them by defendant.

54

xxx

xxx

xxx

. . . On the other hand if the income results from the sale or exchange of the shares in
question then the non-resident alien stockholders who converted their shares abroad have
received no income from Philippine sources and are not subject to any tax whatsoever on
their profits from the transaction.
Leaving aside the other portions of the above-quoted propositions as sufficiently covered in the
court's decision, let us direct attention to those parts thereof wherein it is pretended that the
transaction took place "entirely outside the Philippine Islands" or "abroad."
In the minutes, Schedule B of the stipulation of facts (Rec. on Appeal, pp. 16-17), it appears that
on July 22, 1937, an extraordinary meeting of shareholders of the Manila Wine Merchants, Ltd.
was held and in said meeting, among other things, it was resolved that the Directors of said
company "be authorized and instructed to declare and pay in the form of dividend to the
shareholders the amount of any surplus existing after the above-referred to sale has been
consummated. This surplus, after providing for return of capital and necessary expense, as shown
in the Balance Sheet prepared as of June 1, 1937, after giving effect to the sale transaction abovereferred to, amounts to approximately P270,000." While Schedule B does not state the place
where the meeting was held, Schedule B-1 of the same stipulation of facts (Record on Appeal,
pp. 17-18) furnishes us the information that it was held in Manila. Schedule B-1 in this
connection says:
Sale of Company: In accordance with resolution passed at an Extraordinary Meeting of
Shareholders held in Manila (underscoring supplied) on July 22, 1937, at 3 o'clock, the
Directors of the Manila Wine Merchants Ltd., were authorized to sell the Company as a
going concern in accordance with sale agreement presented at the Meeting.
Later in the same Schedule B-1 we find that the declaration of dividends authorized in the
previous meeting, as stated in the minutes Schedule B, was made by the Board of Directors of
the same Manila Wine Merchants, Ltd., of whose meeting on that same date, July 22, 1937,
Schedule B-1 constitutes the minutes. The pertinent parts to the minutes of said meeting read as
follows:
Dividend: The second matter before the Meeting was the question of declaring a dividend
to enable a distribution in cash to be made, the dividend to be the entire amount standing
at surplus after providing for return of capital and various expenses in accordance with
reconstructed balance sheet as at June 1, 1937 presented by our auditors.
xxx

xxx

xxx

Resolved that as after the Manila Wine Merchants Ltd. has been sold for the stipulated
sum of P400,000 and money received, there will be after providing for return of capital,
payment of income tax and other charges, a sum of approximately P270,000 standing at
surplus account, a dividend is now hereby declared in amount covering the entire balance
remaining at surplus account after the concern has been wound up, and we hereby
55

authorize the distribution of P265,000 as and when funds are available, any balance
remaining to be distributed when final Liquidator's account has been rendered and paid."
Again, while the minutes Schedule B-1 do not reveal the place where that board meeting was
held, the fact stated therein that it was held on July 22,1937, the self-same date of the
extraordinary meeting of shareholders referred to in the minutes Schedule B, at 3 o'clock
(presumably p.m.), as recorded in Schedule B-1, clearly shows that the said board meeting was
held also in Manila, and not in Hongkong or elsewhere abroad, for J.F. Macgregor and E.
Heybrook, both of whom appear in both Schedules B and B-1 to have participated in both
meetings, could not, so far as the record discloses, very well be in Manila and Hongkong or
elsewhere abroad on that same date. There is no showing, nor is it even pretended that these two
gentlemen after the meeting held in Manila on July 22, 1937, at 3 o'clock, took an airplane or
other mode of conveyance, as fast or faster, and hurried to Hongkong or elsewhere abroad and
attended the other meeting that very same day. Indeed, that both meetings must have been held in
Manila would seem to be the only natural and logical supposition from the fact that the Manila
Wine Merchants, Ltd., was admittedly conducting its business in said city and the Philippines in
general (Schedule A, Rec. on Appeal, p. 13). It seems clear, therefore, that the dividends in
question were declared in the Philippine Islands.
What was the legal effect of that declaration? Paragraph V of the stipulation of facts (Rec. on
Appeal, pp. 20-21) states that, pursuant to these resolutions, "the Hongkong Company (the same
Manila Wine Merchants, Ltd.) distributed this surplus to its stockholders, plaintiffs receiving
(underscoring supplied) the following sums on the following dates" (then follow plaintiffs'
names with the respective amounts in Philippine pesos received by them on the dates stated). It is
not stated that they received their dividends in Hongkong or other foreign money . And in their
own brief (p. 25) they say that the payments or distributions thus received by them, as a result of
the liquidation and sale of said company, "were included as gross income in their Philippine
income tax returns". This fact further tends to show that those payments or distributions were
received in the Philippine Islands, either by plaintiffs personally or through their proxies or
agents. Besides, in paragraph V of the stipulation of facts (Rec. on Appeal, p. 21) it appears that
the dividends or distributions pertaining to these individual plaintiffs as well as that pertaining to
their co-plaintiff Wise and Co., Inc., were paid on the same dates, namely, August 24, 1937, and
October 28, 1937; and it being undisputed that Wise and Co., Inc. was domiciled and had its
principal office in Manila (complaint, par. I, Rec. on Appeal, p.2), in which city it was
presumably paid, it would seem obvious that the concomitant payments thus made to the other
plaintiffs were likewise effected in the same place, whether the individual plaintiffs acted
personally or through proxies or agents. It should also be remembered that while the "registered
office" of the Manila Wine Merchants, Ltd. was situated in the colony of Hongkong (Schedule A,
Rec. on Appeal, p. 13), the fact is that the only business for which it was incorporated was the
wine, beer, and spirit business, which had been and was being conducted exclusively within the
Philippine Islands, and from the record we deduce that it had also office in Manila where, so far
as the record discloses, the payments were made. Finally, the fact that payment was made in
Philippine pesos would strongly corroborate the conclusion that it was made in this country if
it had been made in Hongkong or elsewhere abroad, the reasonable assumption is that it would
have been made in Hongkong dollars or in the currency of such other place abroad.

56

. . . However, where a corporation has not only declared a dividend but has specifically
appropriated and set apart from its other assets a fund out of which the dividend is to be
paid, such action constitutes the assets to set apart a trust fund in the hands of the
corporation for the payment of the stockholders to the exclusion of other creditors. . . .
(18 C.J.S., p. 1115; emphasis supplied.)
As between successive owners of shares of stock in a corporation, the general rule is that
dividends belong to the persons who are the owners of the stock at the time they are
declared, without regard to the time during which the dividends were earned, and this is
true although the dividends are made payable at a future date. (18 C.J.S., 119, sec. 470
[a]; emphasis supplied.)
There is no controversy about the legal proposition that dividends declared belong to the
owner of the stock at the time the dividend is declared. (Livingstone County Bank vs.
First State Bank, 136 Ky., 546, 554, cited in footnote 36, p. 818, 14 C.J.; emphasis
supplied.)
The moment the dividend is declared, it becomes then separate and distinct from the stock
and the dividend falls to him who is proprietor of the stock of which it was theretofore
incident.
The doctrine is that a dividend is considered parcel of the mass of corporate property
until declared and therefore incident to and parcel of the stock up to the time it is
declared; and before its declaration, will pass with the sale or devise of the stock.
Whosoever owns the stock prior to the declaration of a dividend, owns the dividend also.
(McLaren vs. Crescent Planning Mill Co., 117 Mo. A., 40, 47, cited in note 36, p. 818, 14
C.J.; emphasis supplied.)
In De Koven vs. Alsop (205 Ill., 309; 63 L.R.A., 587), the court 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 the dividend is
declared, these corporate profits belong to the corporation, not to the stockholders, and
are liable for corporate indebtedness." (Emphasis supplied.)
We are fully satisfied from the facts and data furnished here by the parties themselves that the
dividends in question were paid to plaintiffs, personally or thru their proxies or agents, in the
Philippines. But aside from this, from the moment they were declared and a definite fund
specified for their payment (all surplus remaining "after providing for return of capital and
various expenses") and all of this was done in the Philippines to all legal intents and
purposes they earned those dividends in this country. From the record we deduce that the funds
and assets of the Manila Wine Merchants, Ltd., from which those dividends proceeded, were in
the Philippines where its business was located. So far as the record discloses, its liquidation was
effected in terms of Philippine pesos, indicating that it was made here. And this in turn would
lead to the deduction that the funds and assets liquidated were here.

57

Motion denied. So ordered.

Republic of the Philippines

SUPREME COURT
Manila
EN BANC
G.R. No. L-59431 July 25, 1984
ANTERO M. SISON, JR., petitioner,
vs.
RUBEN B. ANCHETA, Acting Commissioner, Bureau of Internal Revenue;
ROMULO VILLA, Deputy Commissioner, Bureau of Internal Revenue; TOMAS
TOLEDO Deputy Commissioner, Bureau of Internal Revenue; MANUEL ALBA,
Minister of Budget, FRANCISCO TANTUICO, Chairman, Commissioner on Audit,
and CESAR E. A. VIRATA, Minister of Finance, respondents.
58

Antero Sison for petitioner and for his own behalf.

The Solicitor General for respondents.

FERNANDO, C.J.:
The success of the challenge posed in this suit for declaratory relief or prohibition
proceeding 1 on the validity of Section I of Batas Pambansa Blg. 135 depends upon a showing of its constitutional infirmity. The
assailed provision further amends Section 21 of the National Internal Revenue Code of 1977, which provides for rates of tax on citizens or
residents on (a) taxable compensation income, (b) taxable net income, (c) royalties, prizes, and other winnings, (d) interest from bank
deposits and yield or any other monetary benefit from deposit substitutes and from trust fund and similar arrangements, (e) dividends and
2
3
share of individual partner in the net profits of taxable partnership, (f) adjusted gross income. Petitioner as taxpayer alleges

that by virtue thereof, "he would be unduly discriminated against by the imposition of higher rates of tax
upon his income arising from the exercise of his profession vis-a-vis those which are imposed upon fixed
income or salaried individual taxpayers. 4 He characterizes the above sction as arbitrary amounting to
class legislation, oppressive and capricious in character 5 For petitioner, therefore, there is a
transgression of both the equal protection and due process clauses 6 of the Constitution as well as of the
rule requiring uniformity in taxation. 7
The Court, in a resolution of January 26, 1982, required respondents to file an answer within 10 days from
notice. Such an answer, after two extensions were granted the Office of the Solicitor General, was filed on
May 28, 1982. 8 The facts as alleged were admitted but not the allegations which to their mind are "mere
arguments, opinions or conclusions on the part of the petitioner, the truth [for them] being those stated [in
their] Special and Affirmative Defenses." 9 The answer then affirmed: "Batas Pambansa Big. 135 is a valid
exercise of the State's power to tax. The authorities and cases cited while correctly quoted or paraghraph
do not support petitioner's stand." 10 The prayer is for the dismissal of the petition for lack of merit.
This Court finds such a plea more than justified. The petition must be dismissed.
1. It is manifest that the field of state activity has assumed a much wider scope, The reason was so clearly set forth by retired Chief Justice
Makalintal thus: "The areas which used to be left to private enterprise and initiative and which the government was called upon to enter
optionally, and only 'because it was better equipped to administer for the public welfare than is any private individual or group of individuals,'
continue to lose their well-defined boundaries and to be absorbed within activities that the government must undertake in its sovereign
capacity if it is to meet the increasing social challenges of the times." 11 Hence the need for more revenues. The power to tax, an inherent
prerogative, has to be availed of to assure the performance of vital state functions. It is the source of the bulk of public funds. To praphrase a
recent decision, taxes being the lifeblood of the government, their prompt and certain availability is of the essence. 12
2. The power to tax moreover, to borrow from Justice Malcolm, "is an attribute of sovereignty. It is the strongest of all the powers of of
government." 13 It is, of course, to be admitted that for all its plenitude 'the power to tax is not unconfined. There are restrictions. The
Constitution sets forth such limits . Adversely affecting as it does properly rights, both the due process and equal protection clauses inay
properly be invoked, all petitioner does, to invalidate in appropriate cases a revenue measure. if it were otherwise, there would -be truth to
the 1803 dictum of Chief Justice Marshall that "the power to tax involves the power to destroy." 14 In a separate opinion in Graves v. New
York, 15 Justice Frankfurter, after referring to it as an 1, unfortunate remark characterized it as "a flourish of rhetoric [attributable to] the
intellectual fashion of the times following] a free use of absolutes." 16 This is merely to emphasize that it is riot and there cannot be such a
constitutional mandate. Justice Frankfurter could rightfully conclude: "The web of unreality spun from Marshall's famous dictum was brushed
away by one stroke of Mr. Justice Holmess pen: 'The power to tax is not the power to destroy while this Court sits." 17 So it is in the
Philippines.
3. This Court then is left with no choice. The Constitution as the fundamental law overrides any legislative or executive, act that runs counter
to it. In any case therefore where it can be demonstrated that the challenged statutory provision as petitioner here alleges fails to abide
by its command, then this Court must so declare and adjudge it null. The injury thus is centered on the question of whether the imposition of
a higher tax rate on taxable net income derived from business or profession than on compensation is constitutionally infirm.
4, The difficulty confronting petitioner is thus apparent. He alleges arbitrariness. A mere allegation, as here. does not suffice. There must be a
factual foundation of such unconstitutional taint. Considering that petitioner here would condemn such a provision as void or its face, he has
not made out a case. This is merely to adhere to the authoritative doctrine that were the due process and equal protection clauses are
invoked, considering that they arc not fixed rules but rather broad standards, there is a need for of such persuasive character as would lead
to such a conclusion. Absent such a showing, the presumption of validity must prevail. 18

59

5. It is undoubted that the due process clause may be invoked where a taxing statute is so arbitrary that it finds no support in the
Constitution. An obvious example is where it can be shown to amount to the confiscation of property. That would be a clear abuse of power. It
then becomes the duty of this Court to say that such an arbitrary act amounted to the exercise of an authority not conferred. That properly
calls for the application of the Holmes dictum. It has also been held that where the assailed tax measure is beyond the jurisdiction of the
state, or is not for a public purpose, or, in case of a retroactive statute is so harsh and unreasonable, it is subject to attack on due process
grounds. 19
6. Now for equal protection. The applicable standard to avoid the charge that there is a denial of this constitutional mandate whether the
assailed act is in the exercise of the lice power or the power of eminent domain is to demonstrated that the governmental act assailed, far
from being inspired by the attainment of the common weal was prompted by the spirit of hostility, or at the very least, discrimination that finds
no support in reason. It suffices then that the laws operate equally and uniformly on all persons under similar circumstances or that all
persons must be treated in the same manner, the conditions not being different, both in the privileges conferred and the liabilities imposed.
Favoritism and undue preference cannot be allowed. For the principle is that equal protection and security shall be given to every person
under circumtances which if not Identical are analogous. If law be looked upon in terms of burden or charges, those that fall within a class
20
should be treated in the same fashion, whatever restrictions cast on some in the group equally binding on the rest."
That same

formulation applies as well to taxation measures. The equal protection clause is, of course, inspired by
the noble concept of approximating the Ideal of the laws benefits being available to all and the affairs of
men being governed by that serene and impartial uniformity, which is of the very essence of the Idea of
law. There is, however, wisdom, as well as realism in these words of Justice Frankfurter: "The equality at
which the 'equal protection' clause aims is not a disembodied equality. The Fourteenth Amendment
enjoins 'the equal protection of the laws,' and laws are not abstract propositions. They do not relate to
abstract units A, B and C, but are expressions of policy arising out of specific difficulties, address to the
attainment of specific ends by the use of specific remedies. The Constitution does not require things
which are different in fact or opinion to be treated in law as though they were the same." 21 Hence the
constant reiteration of the view that classification if rational in character is allowable. As a matter of fact, in
a leading case of Lutz V. Araneta, 22 this Court, through Justice J.B.L. Reyes, went so far as to hold "at
any rate, it is inherent in the power to tax that a state be free to select the subjects of taxation, and it has
been repeatedly held that 'inequalities which result from a singling out of one particular class for taxation,
or exemption infringe no constitutional limitation.'" 23
7. Petitioner likewise invoked the kindred concept of uniformity. According to the Constitution: "The rule of
taxation shag be uniform and equitable." 24 This requirement is met according to Justice Laurel in
Philippine Trust Company v. Yatco, 25 decided in 1940, when the tax "operates with the same force and
effect in every place where the subject may be found. " 26 He likewise added: "The rule of uniformity does
not call for perfect uniformity or perfect equality, because this is hardly attainable." 27 The problem of
classification did not present itself in that case. It did not arise until nine years later, when the Supreme
Court held: "Equality and uniformity in taxation means that all taxable articles or kinds of property of the
same class shall be taxed at the same rate. The taxing power has the authority to make reasonable and
natural classifications for purposes of taxation, ... . 28 As clarified by Justice Tuason, where "the
differentiation" complained of "conforms to the practical dictates of justice and equity" it "is not
discriminatory within the meaning of this clause and is therefore uniform." 29 There is quite a similarity
then to the standard of equal protection for all that is required is that the tax "applies equally to all
persons, firms and corporations placed in similar situation." 30
8. Further on this point. Apparently, what misled petitioner is his failure to take into consideration the
distinction between a tax rate and a tax base. There is no legal objection to a broader tax base or taxable
income by eliminating all deductible items and at the same time reducing the applicable tax rate.
Taxpayers may be classified into different categories. To repeat, it. is enough that the classification must
rest upon substantial distinctions that make real differences. In the case of the gross income taxation
embodied in Batas Pambansa Blg. 135, the, discernible basis of classification is the susceptibility of the
income to the application of generalized rules removing all deductible items for all taxpayers within the
class and fixing a set of reduced tax rates to be applied to all of them. Taxpayers who are recipients of
compensation income are set apart as a class. As there is practically no overhead expense, these
taxpayers are e not entitled to make deductions for income tax purposes because they are in the same
situation more or less. On the other hand, in the case of professionals in the practice of their calling and
businessmen, there is no uniformity in the costs or expenses necessary to produce their income. It would
not be just then to disregard the disparities by giving all of them zero deduction and indiscriminately
impose on all alike the same tax rates on the basis of gross income. There is ample justification then for

60

the Batasang Pambansa to adopt the gross system of income taxation to compensation income, while
continuing the system of net income taxation as regards professional and business income.
9. Nothing can be clearer, therefore, than that the petition is without merit, considering the (1) lack of
factual foundation to show the arbitrary character of the assailed provision; 31 (2) the force of controlling
doctrines on due process, equal protection, and uniformity in taxation and (3) the reasonableness of the
distinction between compensation and taxable net income of professionals and businessman certainly not
a suspect classification,
WHEREFORE, the petition is dismissed. Costs against petitioner.
Makasiar, Concepcion, Jr., Guerero, Melencio-Herrera, Escolin, Relova, Gutierrez, Jr., De la Fuente and
Cuevas, JJ., concur.
Teehankee, J., concurs in the result.
Plana, J., took no part.

Separate Opinions

AQUINO, J., concurring:

I concur in the result. The petitioner has no cause of action for prohibition.
ABAD SANTOS, J., dissenting:
This is a frivolous suit. While the tax rates for compensation income are lower than
those for net income such circumtance does not necessarily result in lower tax
payments for these receiving compensation income. In fact, the reverse will most likely
be the case; those who file returns on the basis of net income will pay less taxes
because they claim all sort of deduction justified or not I vote for dismissal.

Separate Opinions
AQUINO, J., concurring:
I concur in the result. The petitioner has no cause of action for prohibition.
ABAD SANTOS, J., dissenting:
61

This is a frivolous suit. While the tax rates for compensation income are lower than
those for net income such circumtance does not necessarily result in lower tax
payments for these receiving compensation income. In fact, the reverse will most likely
be the case; those who file returns on the basis of net income will pay less taxes
because they claim all sort of deduction justified or not I vote for dismissal.
Footnotes
1 Petitioner must have realized that a suit for declaratory relief must be filed with Regional Trial Courts.
2 Batas Pambansa Blg. 135, Section 21 (1981).
3 The respondents are Ruben B. Ancheta, Acting Commissioner, Bureau of Internal Revenue; Romulo Villa, Deputy
Commissioner, Bureau of Internal Revenue; Tomas Toledo, Deputy Commissioner, Bureau of Internal Revenue; Manuel
Alba, Minister of Budget; Francisco Tantuico, Chairman, Commissioner on Audit; and Cesar E. A. Virata, Minister of
Finance.
4 Petition, Parties, par. 1. The challenge is thus aimed at paragraphs (a) and (b) of Section 1 further Amending Section
21 of the National Internal Revenue Code of 1977. Par. (a) reads: "(a) On taxable compensation income. A tax is
hereby imposed upon the taxable compensation income as determined in Section 28 (a) received during each taxable
year from all sources by every individual, whether a citizen of the Philippines, determined in accordance with the
following schedule:

Not over P2,500

0%

Over P 2,500 but not over P 5,000

1%

Over P 5,000 but not over 10,000

P 25 + 3% of excess over P 5,000

Over P 10,000 but not over P 20,000

P 175 + 7 % of excess over P 10,000

Over P 20,000 but not over P 40,000

P 875 + 11%, of excess over P 20,000

Over P 40.000 but not over P 60,000

P 3,075 + I 15% of excess over P 40,000

Over P 60,000 but not over P100,000

P 6,075 + 19% of excess over P 60,000

Over P100,000 but not over P250,000

P 13,675 + 24% excess over P100,000

62

Over P250,000 but not over P500,000

P 49,675 + 29% of excess over P250,000

Over P500,000

P 122,175 + 35% of excess over P500,000

Par. (b) reads: "(b) On taxable net income. A tax is hereby imposed upon the taxable net income as determined in
Section 29 (a) received during each taxable year from all sources by every individual, whether a citizen of the
Philippines, or an alien residing in the Philippines determined in accordance with the following schedule:

Not over P10,000

5%

Over P 10,000 but not over P 30,000

P 500 + 15% of excess over P 10,000

Over P 30,000 but not over P150,000

P 3,500 + 30% of excess over P 30,000

Over P150,000 but not over P500,000

P 39,500 + 45% of excess over P150,000

Over P500,000

P197,000 + 601% of excess over P500,000

5 Ibid Statement, par. 4.

6 Article IV, Section 1 of the Constitution reads: "No person shall be deprived of life, liberty or property without due
process of law, nor shall any person be denied the equal protection of the laws."
7 Article VII, Section 7. par. (1) of the Constitution reads: "The rule of taxation shall be uniform and equitable. The
Batasang Pambansa shall evolve a progressive system of taxation."
8 It was filed by Solicitor General Estelito P. Mendoza. He was assisted by Assistant Solicitor General Eduardo D.
Montenegro and Solicitor Erlinda B, Masakayan.
9 Answer, pars. 1-6.
10 Ibid, par. 6.
11 Agricultural Credit and Cooperative Financing Administration v. Consideration of Unions in Government Corporation
and Offices, L-21484, November 29, 1969, 30 SCRA 649, 662.
12 Cf, Vera v. Fernandez, L-31364, March 30, 1979, 89 SCRA 199, per Castro, J.
13 Sarasola v. Trinidad, 40 Phil. 252, 262 (1919).
14 McColloch v. Maryland 4 Wheaton 316,

63

15 306 US 466 ( 938).

16 Ibid, 489
17 Ibid. 490.
18 Cf. Ermita-Malate Hotel and Motel Operator S Association v. Hon. City Mayor, 127 Phil. 306, 315 ( 1967); U.S. v.
Salaveria, 39 Phil. 102,111 (1918) and Ebona v. Daet, 85 Phil, 369 (1950). Likewise referred to is O'Gorman and Young
v. Hartford Fire Insurance Co 282 US 251, 328 (1931).
19 Cf. Manila Gas Co. v. Collector of Internal Revenue, 62 Phil. 895 (1936); Wells Fargo Bank and Union Trust Co. v.
Collector, 70 Phil. 325 (1940); Republic v. Oasan Vda. de Fernandez, 99 Phil. 934 (1956).
20 The excerpt is from the opinion in J.M. Tuason and Co. v. The Land Tenure Administration, L-21064, February 18,
1970, 31 SCRA 413, 435 and reiterated in Bautista v. Juinio, G.R. No. 50908, January 31, 1984, 127 SCRA 329, 339.
The former deals with an eminent domain proceeding and the latter with a suit contesting the validity of a police power
measure.
21 Tigner v. Texas, 310 US 141, 147 (1940).
22 98 Phil. 148 (1955).
23 Ibid, 153.
24 Article VIII, Section 17, par. 1, first sentence of the Constitution
25 69 Phil. 420 (1940).
26 Ibid, 426.
27 Ibid, 424.
28 Eastern Theatrical Co. v. Alfonso, 83 Phil. 852, 862 (1949).
29 Manila Race Horse Trainers Asso. v. De la Fuente, 88 Phil. 60,65 (1951).
30 Uy Matias v. City of Cebu, 93 Phil. 300 (1953).
31 While petitioner cited figures to sustain in his assertion, public respondents refuted with other figures that argue
against his submission. One reason for requiring declaratory relief proceedings to start in regional trial courts is
precisely to enable petitioner to prove his allegation, absent an admission in the answer.

64

Republic of the Philippines

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

August 7, 1918

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

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION,
Deputy Collector of Internal Revenue, defendants-appellees.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:
This appeal calls for consideration of the Income Tax Law, a law of American origin, with
reference to the Civil Code, a law of Spanish origin.
STATEMENT OF THE CASE.
Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The
marriage was contracted under the provisions of law concerning conjugal partnerships (sociedad
de gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on the
prescribed form with the Collector of Internal Revenue, showing, as his total net income for the
year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the claim that the said
P296,302.73 did not represent his income for the year 1914, but was in fact the income of the
conjugal partnership existing between himself and his wife Susana Paterno, and that in
computing and assessing the additional income tax provided by the Act of Congress of October
3, 1913, the income declared by Vicente Madrigal should be divided into two equal parts, onehalf to be considered the income of Vicente Madrigal and the other half of Susana Paterno. The
general question had in the meantime been submitted to the Attorney-General of the Philippine
Islands who in an opinion dated March 17, 1915, held with the petitioner Madrigal. The revenue
65

officers being still unsatisfied, the correspondence together with this opinion was forwarded to
Washington for a decision by the United States Treasury Department. The United States
Commissioner of Internal Revenue reversed the opinion of the Attorney-General, and thus
decided against the claim of Madrigal.
After payment under protest, and after the protest of Madrigal had been decided adversely by the
Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana
Paterno in the Court of First Instance of the city of Manila against Collector of Internal Revenue
and the Deputy Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged
to have been wrongfully and illegally collected by the defendants from the plaintiff, Vicente
Madrigal, under the provisions of the Act of Congress known as the Income Tax Law. The
burden of the complaint was that if the income tax for the year 1914 had been correctly and
lawfully computed there would have been due payable by each of the plaintiffs the sum of
P2,921.09, which taken together amounts of a total of P5,842.18 instead of P9,668.21,
erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with the result that
plaintiff Madrigal has paid as income tax for the year 1914, P3,786.08, in excess of the sum
lawfully due and payable.
The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and
the stipulation, sets forth the basis of defendants' stand in the following way: The income of
Vicente Madrigal and his wife Susana Paterno of the year 1914 was made up of three items: (1)
P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2)
P4,086.50, the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the
profits made by Vicente Madrigal in a pawnshop company. The sum of these three items is
P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the year 1914.
General deductions were claimed and allowed in the sum of P86,879.24. The resulting net
income was P296,302.73. For the purpose of assessing the normal tax of one per cent on the net
income there were allowed as specific deductions the following: (1) P16,687.80, the tax upon
which was to be paid at source, and (2) P8,000, the specific exemption granted to Vicente
Madrigal and Susana Paterno, husband and wife. The remainder, P271,614.93 was the sum upon
which the normal tax of one per cent was assessed. The normal tax thus arrived at was
P2,716.15.
The dispute between the plaintiffs and the defendants concerned the additional tax provided for
in the Income Tax Law. The trial court in an exhausted decision found in favor of defendants,
without costs.
ISSUES.
The contentions of plaintiffs and appellants having to do solely with the additional income tax, is
that is should be divided into two equal parts, because of the conjugal partnership existing
between them. The learned argument of counsel is mostly based upon the provisions of the Civil
Code establishing the sociedad de gananciales. The counter contentions of appellees are that the
taxes imposed by the Income Tax Law are as the name implies taxes upon income tax and not
upon capital and property; that the fact that Madrigal was a married man, and his marriage
contracted under the provisions governing the conjugal partnership, has no bearing on income
66

considered as income, and that the distinction must be drawn between the ordinary form of
commercial partnership and the conjugal partnership of spouses resulting from the relation of
marriage.
DECISION.
From the point of view of test of faculty in taxation, no less than five answers have been given
the course of history. The final stage has been the selection of income as the norm of taxation.
(See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States,
extended to the Philippine Islands, is the result of an effect on the part of the legislators to put
into statutory form this canon of taxation and of social reform. The aim has been to mitigate the
evils arising from inequalities of wealth by a progressive scheme of taxation, which places the
burden on those best able to pay. To carry out this idea, public considerations have demanded an
exemption roughly equivalent to the minimum of subsistence. With these exceptions, the income
tax is supposed to reach the earnings of the entire non-governmental property of the country.
Such is the background of the Income Tax Law.
Income as contrasted with capital or property is to be the test. The essential difference between
capital and income is that capital is a fund; income is a flow. A fund of property existing at an
instant of time is called capital. A flow of services rendered by that capital by the payment of
money from it or any other benefit rendered by a fund of capital in relation to such fund
through a period of time is called an income. Capital is wealth, while income is the service of
wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia
expresses the thought in the following figurative language: "The fact is that property is a tree,
income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring
vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on property. "Income," as
here used, can be defined as "profits or gains." (London County Council vs. Attorney-General
[1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas.,
265. See further Foster's Income Tax, second edition [1915], Chapter IV; Black on Income Taxes,
second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U.S., 549; and Towne vs.
Eisner, decided by the United States Supreme Court, January 7, 1918.)
A regulation of the United States Treasury Department relative to returns by the husband and
wife not living apart, contains the following:
The husband, as the head and legal representative of the household and general custodian of its
income, should make and render the return of the aggregate income of himself and wife, and for
the purpose of levying the income tax it is assumed that he can ascertain the total amount of said
income. If a wife has a separate estate managed by herself as her own separate property, and
receives an income of more than $3,000, she may make return of her own income, and if the
husband has other net income, making the aggregate of both incomes more than $4,000, the
wife's return should be attached to the return of her husband, or his income should be included in
her return, in order that a deduction of $4,000 may be made from the aggregate of both incomes.
The tax in such case, however, will be imposed only upon so much of the aggregate income of
both shall exceed $4,000. If either husband or wife separately has an income equal to or in
excess of $3,000, a return of annual net income is required under the law, and such return must
67

include the income of both, and in such case the return must be made even though the combined
income of both be less than $4,000. If the aggregate net income of both exceeds $4,000, an
annual return of their combined incomes must be made in the manner stated, although neither
one separately has an income of $3,000 per annum. They are jointly and separately liable for
such return and for the payment of the tax. The single or married status of the person claiming
the specific exemption shall be determined as one of the time of claiming such exemption which
return is made, otherwise the status at the close of the year."
With these general observations relative to the Income Tax Law in force in the Philippine
Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the
conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the conjugal partnership, decided that "prior to
the liquidation the interest of the wife and in case of her death, of her heirs, is an interest
inchoate, a mere expectancy, which constitutes neither a legal nor an equitable estate, and does
not ripen into title until there appears that there are assets in the community as a result of the
liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and
Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)
Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband
Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate
property rights and in the ultimate ownership of property acquired as income after such income
has become capital. Susana Paterno has no absolute right to one-half the income of the conjugal
partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return
in order to receive the benefit of the exemption which would arise by reason of the additional
tax. As she has no estate and income, actually and legally vested in her and entirely distinct from
her husband's property, the income cannot properly be considered the separate income of the
wife for the purposes of the additional tax. Moreover, the Income Tax Law does not look on the
spouses as individual partners in an ordinary partnership. The husband and wife are only entitled
to the exemption of P8,000 specifically granted by the law. The higher schedules of the
additional tax directed at the incomes of the wealthy may not be partially defeated by reliance on
provisions in our Civil Code dealing with the conjugal partnership and having no application to
the Income Tax Law. The aims and purposes of the Income Tax Law must be given effect.
The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter
overruling the opinion of the Attorney-General is as follows:
TREASURY DEPARTMENT, Washington.
Income Tax.
FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.

68

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission of
income tax returns by marred person."
You advise that "The Governor-General, in forwarding the papers to the Bureau, advises
that the Insular Auditor has been authorized to suspend action on the warrants in question
until an authoritative decision on the points raised can be secured from the Treasury
Department."
From the correspondence it appears that Gregorio Araneta, married and living with his
wife, had an income of an amount sufficient to require the imposition of the net income
was properly computed and then both income and deductions and the specific exemption
were divided in half and two returns made, one return for each half in the names
respectively of the husband and wife, so that under the returns as filed there would be an
escape from the additional tax; that Araneta claims the returns are correct on the ground
under the Philippine law his wife is entitled to half of his earnings; that Araneta has
dominion over the income and under the Philippine law, the right to determine its use and
disposition; that in this case the wife has no "separate estate" within the contemplation of
the Act of October 3, 1913, levying an income tax.
It appears further from the correspondence that upon the foregoing explanation, tax was
assessed against the entire net income against Gregorio Araneta; that the tax was paid and
an application for refund made, and that the application for refund was rejected,
whereupon the matter was submitted to the Attorney-General of the Islands who holds
that the returns were correctly rendered, and that the refund should be allowed; and
thereupon the question at issue is submitted through the Governor-General of the Islands
and Bureau of Insular Affairs for the advisory opinion of this office.
By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be
administered as in the United States but by the appropriate internal-revenue officers of
the Philippine Government. You are therefore advised that upon the facts as stated, this
office holds that for the Federal Income Tax (Act of October 3, 1913), the entire net
income in this case was taxable to Gregorio Araneta, both for the normal and additional
tax, and that the application for refund was properly rejected.
The separate estate of a married woman within the contemplation of the Income Tax Law
is that which belongs to her solely and separate and apart from her husband, and over
which her husband has no right in equity. It may consist of lands or chattels.
The statute and the regulations promulgated in accordance therewith provide that each
person of lawful age (not excused from so doing) having a net income of $3,000 or over
for the taxable year shall make a return showing the facts; that from the net income so
shown there shall be deducted $3,000 where the person making the return is a single
person, or married and not living with consort, and $1,000 additional where the person
making the return is married and living with consort; but that where the husband and wife

69

both make returns (they living together), the amount of deduction from the aggregate of
their several incomes shall not exceed $4,000.
The only occasion for a wife making a return is where she has income from a sole and
separate estate in excess of $3,000, but together they have an income in excess of $4,000,
in which the latter event either the husband or wife may make the return but not both. In
all instances the income of husband and wife whether from separate estates or not, is
taken as a whole for the purpose of the normal tax. Where the wife has income from a
separate estate makes return made by her husband, while the incomes are added together
for the purpose of the normal tax they are taken separately for the purpose of the
additional tax. In this case, however, the wife has no separate income within the
contemplation of the Income Tax Law.
Respectfully,

DAVID A. GATES.
Acting Commissioner.

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

70

Republic of the Philippines

SUPREME COURT
Manila
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, petitioners,
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-LIACCO, 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, petitioners,
vs.
THE HONORABLE COURT OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.
Angara, Abello, Concepcion, Regala & Cruz for petitioners.

NOCON, J.:
Petitioners pray that his Court reverse the Decision of the public respondent Court of Tax Appeals, promulgated September 26, 1977

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 follows:

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Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine
Manufacturing Corporation, with offices at Sarmiento Building, Ayala Avenue, Makati,
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 were assigned, for
certain periods, to other subsidiaries of Procter & Gamble, outside of the Philippines,
during which petitioners were paid 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 May 14, 1970, as follows:
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 P6.25
to 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 with 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. 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 were filed with respondent Commissioner. Without awaiting
the resolution of the Commissioner of the Internal Revenue on their claims, petitioners
filed their petitioner for review in the above-mentioned cases.
Respondent Commissioner filed his Answer to petitioners' petition for review in C.T.A.
Case No. 2511 on July 31, 1973, while his Answer in C.T.A. Case No. 2594 was filed on
August 7, 1974.
Upon joint motion of the parties on the ground that these two cases involve common
question of law and facts, that 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
Memorandum 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 erred in holding:
1. That petitioners' dollar earnings are receipts derived from foreign exchange transactions.

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2. That the proper rate of conversion of petitioners' dollar earnings for tax purposes in 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 rate used.
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 two cases 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 implementing rules and regulations, and not by the provisions of
Central Bank Circular No. 42 dated May 21, 1953, as contended by petitioners.
Section 21 of the National Internal Revenue Code, before its amendment by Presidential
Decrees Nos. 69 and 323 which took effect on January 1, 1973 and January 1, 1974,
respectively, imposed a tax upon the taxable net income received during each taxable
year from all sources by a citizen of the Philippines, whether residing here or abroad.
Petitioners are citizens of the Philippines temporarily residing abroad by virtue of their
employment. Thus, in their tax returns for the period involved herein, they gave their legal
residence/address as c/o Procter & Gamble PMC, Ayala Ave., Makati, Rizal (Annexes "A"
to "A-8" and Annexes "C" to "C-8", Petition for Review, CTA 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 with the provisions of Revenue Memorandum 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, which reiterated BIR Ruling No. 70-027 dated May
4, 1970, to wit:
For internal revenue tax purposes, the free marker 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 laws involved and the jurisprudence on the matter, We are
inclined to agree with respondents Court of Tax Appeals and Commissioner of Internal Revenue and thus
vote to deny the petition.
This basically an income tax case. For the proper resolution of these cases income may be defined as an
amount of money coming to a person or corporation within a specified time, whether as payment for
services, interest or profit from investment . Unless otherwise specified, it means cash or its equivalent. 4
Income can also be though of as 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

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an equivalent amount of money or currency of another." 6 When petitioners were assigned to the foreign
subsidiaries of Procter & Gamble, they were earning in their assigned nation's currency and were ALSO
spending in said currency. There was no conversion, therefore, from one currency to another.
Public respondent Court of Tax Appeals did err when 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, what exchange rate 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
within the classification of foreign exchange transactions, there occurred no actual inward remittances,
and, therefore, they are not included in the coverage of Central Bank Circular No. 289 which provides for
the specific instances when 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 shows 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 was a definite amount of
money which came to them within a specified period of time of two yeas as payment for their services.
Section 21 of the National Internal Revenue Code, amended up to August 4, 1969, states as follows:
Sec. 21. Rates of tax on citizens or residents. A tax is hereby imposed upon the taxable net income received during
each taxable year from all sources by every individual, whether a citizen of the Philippines residing therein or abroad or
an alien residing in the Philippines, determined in accordance with the following schedule:
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.

Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71 10 and 41-71 11 were issued to
prescribed 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 were a valid exercise of
the authority given to the Secretary of Finance by the Legislature which 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 wages 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, within or without, and in these cases wholly without,
are subject to income tax. Sec. 21, NIRC, as amended, does not brook any exemption.

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Since petitioners have already paid their 1970 and 1971 income taxes under the uniform rate of exchange
prescribed under the aforestated Revenue Memorandum 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 worn-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.
WHEREFORE, the petitioners 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 1971 is AFFIRMED.
Costs against petitioners.
SO ORDERED.

Republic of the Philippines

SUPREME COURT
Manila
THIRD DIVISION
G.R. No. 172231

February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
ISABELA CULTURAL CORPORATION, Respondent.
DECISION
YNARES-SANTIAGO, J.:
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Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision1 of
the Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision2 of the
Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the
Assessment Notices for deficiency income tax and expanded withholding tax issued by the
Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC).
The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR
Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of
P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded
withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the
taxable year 1986.
The deficiency income tax of P333,196.86, arose from:
(1) The BIRs disallowance of ICCs claimed expense deductions for professional and
security services billed to and paid by ICC in 1986, to wit:
(a) Expenses for the auditing services of SGV & Co.,3 for the year ending
December 31, 1985;4
(b) Expenses for the legal services [inclusive of retainer fees] of the law firm
Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984
and 1985.5
(c) Expense for security services of El Tigre Security & Investigation Agency for
the months of April and May 1986.6
(2) The alleged understatement of ICCs interest income on the three promissory notes
due from Realty Investment , Inc.
The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was
allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed
P244,890.00 deduction for security services.7
On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9,
1995, however, it received a final notice before seizure demanding payment of the amounts
stated in the said notices. Hence, it brought the case to the CTA which held that the petition is
premature because the final notice of assessment cannot be considered as a final decision
appealable to the tax court. This was reversed by the Court of Appeals holding that a demand
letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the
protested assessment and may therefore be questioned before the CTA. This conclusion was
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sustained by this Court on July 1, 2001, in G.R. No. 135210.8 The case was thus remanded to the
CTA for further proceedings.
On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment
notices issued against ICC. It held that the claimed deductions for professional and security
services were properly claimed by ICC in 1986 because it was only in the said year when the
bills demanding payment were sent to ICC. Hence, even if some of these professional services
were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said
years as the amount thereof could not be determined at that time.
The CTA also held that ICC did not understate its interest income on the subject promissory
notes. It found that it was the BIR which made an overstatement of said income when it
compounded the interest income receivable by ICC from the promissory notes of Realty
Investment , Inc., despite the absence of a stipulation in the contract providing for a
compounded interest; nor of a circumstance, like delay in payment or breach of contract, that
would justify the application of compounded interest.
Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed
deduction for security services as shown by the various payment orders and confirmation
receipts it presented as evidence. The dispositive portion of the CTAs Decision, reads:
WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for
deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of
surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET
ASIDE.
SO ORDERED.9
Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA
decision,10 holding that although the professional services (legal and auditing services) were
rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time,
hence, it could be considered as deductible expenses only in 1986 when ICC received the billing
statements for said services. It further ruled that ICC did not understate its interest income from
the promissory notes of Realty Investment , Inc., and that ICC properly withheld and remitted
taxes on the payments for security services for the taxable year 1986.
Hence, petitioner, through the Office of the Solicitor General, filed the instant petition
contending that since ICC is using the accrual method of accounting, the expenses for the
professional services that accrued in 1984 and 1985, should have been declared as deductions
from income during the said years and the failure of ICC to do so bars it from claiming said
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expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and
failure to withhold expanded withholding tax assessment, petitioner invoked the presumption
that the assessment notices issued by the BIR are valid.
The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of
the expenses for professional and security services from ICCs gross income; and (2) held that
ICC did not understate its interest income from the promissory notes of Realty Investment , Inc;
and that ICC withheld the required 1% withholding tax from the deductions for security services.
The requisites for the deductibility of ordinary and necessary trade, business, or professional
expenses, like expenses paid for legal and auditing services, are: (a) the expense must be
ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must
have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be
supported by receipts, records or other pertinent papers.11
The requisite that it must have been paid or incurred during the taxable year is further qualified
by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction
provided for in this Title shall be taken for the taxable year in which paid or accrued or paid or
incurred, dependent upon the method of accounting upon the basis of which the net income is
computed x x x".
Accounting methods for tax purposes comprise a set of rules for determining when and how to
report income and deductions.12 In the instant case, the accounting method used by ICC is the
accrual method.
Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of
accounting, expenses not being claimed as deductions by a taxpayer in the current year when
they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a
taxpayer who is authorized to deduct certain expenses and other allowable deductions for the
current year but failed to do so cannot deduct the same for the next year.13
The accrual method relies upon the taxpayers right to receive amounts or its obligation to pay
them, in opposition to actual receipt or payment, which characterizes the cash method of
accounting. Amounts of income accrue where the right to receive them become fixed, where
there is created an enforceable liability. Similarly, liabilities are accrued when fixed and
determinable in amount, without regard to indeterminacy merely of time of payment.14
For a taxpayer using the accrual method, the determinative question is, when do the facts present
themselves in such a manner that the taxpayer must recognize income or expense? The accrual of
income and expense is permitted when the all-events test has been met. This test requires: (1)

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fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate
determination of such income or liability.
The all-events test requires the right to income or liability be fixed, and the amount of such
income or liability be determined with reasonable accuracy. However, the test does not demand
that the amount of income or liability be known absolutely, only that a taxpayer has at his
disposal the information necessary to compute the amount with reasonable accuracy. The allevents test is satisfied where computation remains uncertain, if its basis is unchangeable; the test
is satisfied where a computation may be unknown, but is not as much as unknowable, within the
taxable year. The amount of liability does not have to be determined exactly; it must be
determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy"
implies something less than an exact or completely accurate amount.[15]
The propriety of an accrual must be judged by the facts that a taxpayer knew, or could
reasonably be expected to have known, at the closing of its books for the taxable year.[16]
Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the
burden of proof of establishing the accrual of an item of income or deduction.17
Corollarily, it is a governing principle in taxation that tax exemptions must be construed in
strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who
claims an exemption must be able to justify the same by the clearest grant of organic or statute
law. An exemption from the common burden cannot be permitted to exist upon vague
implications. And since a deduction for income tax purposes partakes of the nature of a tax
exemption, then it must also be strictly construed.18
In the instant case, the expenses for professional fees consist of expenses for legal and auditing
services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of
the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for
reimbursement of the expenses of said firm in connection with ICCs tax problems for the year
1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960s.19 From
the nature of the claimed deductions and the span of time during which the firm was retained,
ICC can be expected to have reasonably known the retainer fees charged by the firm as well as
the compensation for its legal services. The failure to determine the exact amount of the expense
during the taxable year when they could have been claimed as deductions cannot thus be
attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the
exercise of due diligence could have inquired into the amount of their obligation to the firm,
especially so that it is using the accrual method of accounting. For another, it could have
reasonably determined the amount of legal and retainer fees owing to its familiarity with the
rates charged by their long time legal consultant.

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As previously stated, the accrual method presents largely a question of fact and that the taxpayer
bears the burden of establishing the accrual of an expense or income. However, ICC failed to
discharge this burden. As to when the firms performance of its services in connection with the
1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire
about the amount of its liability, or whether it does or does not possess the information necessary
to compute the amount of said liability with reasonable accuracy, are questions of fact which
ICC never established. It simply relied on the defense of delayed billing by the firm and the
company, which under the circumstances, is not sufficient to exempt it from being charged with
knowledge of the reasonable amount of the expenses for legal and auditing services.
In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC
for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because
ICC failed to present evidence showing that even with only "reasonable accuracy," as the
standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the
professional fees which said company would charge for its services.
ICC thus failed to discharge the burden of proving that the claimed expense deductions for the
professional services were allowable deductions for the taxable year 1986. Hence, per Revenue
Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income
for the said year and were therefore properly disallowed by the BIR.
As to the expenses for security services, the records show that these expenses were incurred by
ICC in 198620 and could therefore be properly claimed as deductions for the said year.
Anent the purported understatement of interest income from the promissory notes of Realty
Investment , Inc., we sustain the findings of the CTA and the Court of Appeals that no such
understatement exists and that only simple interest computation and not a compounded one
should have been applied by the BIR. There is indeed no stipulation between the latter and ICC
on the application of compounded interest.21 Under Article 1959 of the Civil Code, unless there is
a stipulation to the contrary, interest due should not further earn interest.
Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required
withholding tax from its claimed deductions for security services and remitted the same to the
BIR is supported by payment order and confirmation receipts.22 Hence, the Assessment Notice
for deficiency expanded withholding tax was properly cancelled and set aside.
In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for
deficiency income tax should be cancelled and set aside but only insofar as the claimed
deductions of ICC for security services. Said Assessment is valid as to the BIRs disallowance of
ICCs expenses for professional services. The Court of Appeals cancellation of Assessment

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Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency expanded

withholding tax, is sustained.
WHEREFORE, the petition is PARTIALLY GRANTED. The September 30, 2005 Decision of
the Court of Appeals in CA-G.R. SP No. 78426, is AFFIRMED with the MODIFICATION that
Assessment Notice No. FAS-1-86-90-000680, which disallowed the expense deduction of
Isabela Cultural Corporation for professional and security services, is declared valid only insofar
as the expenses for the professional fees of SGV & Co. and of the law firm, Bengzon Zarraga
Narciso Cudala Pecson Azcuna & Bengson, are concerned. The decision is affirmed in all other
respects.
The case is remanded to the BIR for the computation of Isabela Cultural Corporations liability
under Assessment Notice No. FAS-1-86-90-000680.
SO ORDERED.

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