WHO IS AN EMPLOYEE- DIRECTOR’S BONUS

G.R. No. 197117 April 10, 2013

FIRST LEPANTO TAISHO INSURANCE CORPORATION, Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

DECISION

MENDOZA, J.:

Before the Court is a petition for review on certiorari1 under Rule 45 of the 1997 Rules of Civil Procedure
filed by First Lepanto Taisho Corporation, now FLT Prime Insurance Corporation (petitioner), assailing
the March l, 2011 Decision2 and the May 27, 2011 Resolution3 of the Court of Tax Appeals (CTA) En
Bane, in CTA E.B. No. 563, which affirmed the May 21, 2009 Decision of the CTA-Second Division.

The Facts:

Petitioner is a non-lire insurance corporation and considered as a "Large Taxpayer under Revenue
Regulations No. 6-85, as amended by Revenue Regulations No. 12-94 effective 1994."4 After submitting
its corporate income tax return for taxable year ending December 31, 1997, petitioner received a Letter
of Authority, dated October 30, 1998, from respondent Commissioner of Internal Revenue (CIR) to allow
it to examine their books of account and other accounting records for 1997 and other unverified prior
years.

On December 29, 1999, CIR issued internal revenue tax assessments for deficiency income, withholding,
expanded withholding, final withholding, value-added, and documentary stamp taxes for taxable year
1997.

On February 24, 2000, petitioner protested the said tax assessments.

During the pendency of the case, particularly on February 15, 2008, petitioner filed its Motion for Partial
Withdrawal of Petition for Review of Assessment Notice Nos. ST-INC-97-0220-99; ST-VAT-97-0222-99
and ST-DST-97-0217-00, in view of the tax amnesty program it had availed. The CTA Second Division
granted the said motion in a Resolution,5 dated March 31, 2008.

Consequently, on May 21, 2009, the CTA Second Division partially granted the petition.6 It directed
petitioner to pay CIR a reduced tax liability of ₱1,994,390.86. The dispositive portion reads:

WHEREFORE, in view of the foregoing considerations, the instant Petition for Review is hereby
PARTIALLY GRANTED. Accordingly, petitioner is hereby ORDERED TO PAY deficiency withholding tax on
compensation, expanded withholding tax and final tax in the reduced amount of ₱1,994,390.86,
computed as follows:
Petitioner’s Motion for Partial Reconsideration7 was likewise denied by the CTA Second Division in its
October 29, 2009 Resolution.8

Unsatisfied, petitioner filed a Petition for Review before the CTA En Banc.9

On March 1, 2011, the CTA En Banc affirmed the decision of the CTA Second Division.10

Petitioner contended that it was not liable to pay Withholding Tax on Compensation on the ₱500,000.00
Director’s Bonus to their directors, specifically, Rodolfo Bausa, Voltaire Gonzales, Felipe Yap, and
Catalino Macaraig, Jr., because they were not employees and the amount was already subjected to
Expanded Withholding Tax. The CTA En Banc, however, ruled that Section 5 of Revenue Regulation No.
12-86 expressly identified a director to be an employee.

As to transportation, subsistence and lodging, and representation expenses, the expenses would not be
subject to withholding tax only if the same were reimbursement for actual expenses of the company. In
the present case, the CTA En Banc declared that petitioner failed to prove that they were so.

As to deficiency expanded withholding taxes on compensation, petitioner failed to substantiate that the
commissions earned totaling ₱905,428.36, came from reinsurance activities and should not be subject
to withholding tax. Petitioner likewise failed to prove its direct loss expense, occupancy cost and
service/contractors and purchases.

As to deficiency final withholding taxes, "petitioner failed to present proof of remittance to establish
that it had remitted the final tax on dividends paid as well as the payments for services rendered by the
Malaysian entity."11

As to the imposition of delinquency interest under Section 249 (c) (3) of the 1997 National Internal
Revenue Code (NIRC), records reveal that petitioner failed to pay the deficiency taxes within thirty (30)
days from receipt of the demand letter, thus, delinquency interest accrued from such non-payment.

Petitioner moved for partial reconsideration, but the CTA En Banc denied the same in its May 27, 2011
Resolution.12

Hence, this petition.13

The principal issue in this case is whether the CTA En Banc erred in holding petitioner liable for:

a. deficiency withholding taxes on compensation on directors’ bonuses under Assessment No. ST-WC-
97-0021-99;

b. deficiency expanded withholding taxes on transportation, subsistence and lodging, and

representation expense; commission expense; direct loss expense; occupancy cost; and
service/contractor and purchases under Assessment No. ST-EWT-97-0218-99;
c. deficiency final withholding taxes on payment of dividends and computerization expenses to foreign
entities under Assessment No. ST-FT-97-0219-99; and

d. delinquency interest under Section 249 (c) (3) of the NIRC.

The Court finds no merit in the petition.

For taxation purposes, a director is considered an employee under Section 5 of Revenue Regulation No.
12-86,14 to wit:

An individual, performing services for a corporation, whether as an officer and director or merely as a
director whose duties are confined to attendance at and participation in the meetings of the Board of
Directors, is an employee.

The non-inclusion of the names of some of petitioner’s directors in the company’s Alpha List does not
ipso facto create a presumption that they are not employees of the corporation, because the imposition
of withholding tax on compensation hinges upon the nature of work performed by such individuals in
the company. Moreover, contrary to petitioner’s attestations, Revenue Regulation No. 2-
98,15 specifically, Section 2.57.2. A (9) thereof,16 cannot be applied to this case as the latter is a later
regulation while the accounting books examined were for taxable year 1997.

As to the deficiency withholding tax assessment on transportation, subsistence and lodging, and
representation expense, commission expense, direct loss expense, occupancy cost, service/contractor
and purchases, the Court finds no cogent reason to deviate from the findings of the CTA En Banc. As
correctly observed by the CTA Second Division and the CTA En Banc, petitioner was not able to
sufficiently establish that the transportation expenses reflected in their books were reimbursement
from actual transportation expenses incurred by its employees in connection with their duties as the
only document presented was a Schedule of Transportation

Expenses without pertinent supporting documents. Without said documents, such as but not limited to,
receipts, transportation-related vouchers and/or invoices, there is no way of ascertaining whether the
amounts reflected in the schedule of expenses were disbursed for transportation.

With regard to commission expense, no additional documentary evidence, like the reinsurance
agreements contracts, was presented to support petitioner’s allegation that the expenditure originated
from reinsurance activities that gave rise to reinsurance commissions, not subject to withholding tax. As
to occupancy costs, records reveal that petitioner failed to compute the correct total occupancy cost
that should be subjected to withholding tax, hence, petitioner is liable for the deficiency.

As to service/contractors and purchases, petitioner contends that both parties already stipulated that it
correctly withheld the taxes due. Thus, petitioner is of the belief that it is no longer required to present
evidence to prove the correct payment of taxes withheld. As correctly ruled by the CTA Second Division
and En Bane, however, stipulations cannot defeat the right of the State to collect the correct taxes due
on an individual or juridical person because taxes are the lifeblood of our nation so its collection should
be actively pursued without unnecessary impediment.
As to the deficiency final withholding tax assessments for payments of dividends and computerization
expenses incurred by petitioner to foreign entities, particularly Matsui Marine & Fire Insurance Co. Ltd.
(Matsui),17 the Court agrees with CIR that petitioner failed to present evidence to show the supposed
remittance to Matsui.

The Court likewise holds the imposition of delinquency interest under Section 249 (c) (3) of the 1997
NIRC to be proper, because failure to pay the deficiency tax assessed within the time prescribed for its
payment justifies the imposition of interest at the rate of twenty percent (20%) per annum, which
interest shall be assessed and collected from the date prescribed for its payment until full payment is
made.

It is worthy to note that tax revenue statutes are not generally intended to be liberally
construed.18 Moreover, the CTA being a highly specialized court particularly created for the purpose of
reviewing tax and customs cases, it is settled that its findings and conclusions are accorded great respect
and are generally upheld by this Court, unless there is a clear showing of a reversible error or an
improvident exercise of authority.19 Absent such errors, the challenged decision should be maintained.

WHEREFORE, the petition is DENIED. The March 1, 2011 Decision and the May 27, 2011 Resolution of
the Court of Tax Appeals En Bane, in CTA E.B. No. 563, are AFFIRMED.

SO ORDERED.

DAVID G. NITAFAN, WENCESLAO M. POLO, and MAXIMO A. SAVELLANO, JR., petitioners,

vs.
COMMISSIONER OF INTERNAL REVENUE and THE FINANCIAL OFFICER, SUPREME COURT OF THE
PHILIPPINES, respondents.

RESOLUTION

MELENCIO-HERRERA, J.:

Petitioners, the duly appointed and qualified Judges presiding over Branches 52, 19 and 53, respectively,
of the Regional Trial Court, National Capital Judicial Region, all with stations in Manila, seek to prohibit
and/or perpetually enjoin respondents, the Commissioner of Internal Revenue and the Financial Officer
of the Supreme Court, from making any deduction of withholding taxes from their salaries.

In a nutshell, they submit that "any tax withheld from their emoluments or compensation as judicial
officers constitutes a decrease or diminution of their salaries, contrary to the provision of Section 10,
Article VIII of the 1987 Constitution mandating that "(d)uring their continuance in office, their salary
shall not be decreased," even as it is anathema to the Ideal of an independent judiciary envisioned in
and by said Constitution."
It may be pointed out that, early on, the Court had dealt with the matter administratively in response to
representations that the Court direct its Finance Officer to discontinue the withholding of taxes from
salaries of members of the Bench. Thus, on June 4, 1987, the Court en banc had reaffirmed the Chief
Justice's directive as follows:

RE: Question of exemption from income taxation. — The Court REAFFIRMED the Chief Justice's previous
and standing directive to the Fiscal Management and Budget Office of this Court to continue with the
deduction of the withholding taxes from the salaries of the Justices of the Supreme Court as well as from
the salaries of all other members of the judiciary.

That should have resolved the question. However, with the filing of this petition, the Court has deemed
it best to settle the legal issue raised through this judicial pronouncement. As will be shown hereinafter,
the clear intent of the Constitutional Commission was to delete the proposed express grant of
exemption from payment of income tax to members of the Judiciary, so as to "give substance to equality
among the three branches of Government" in the words of Commissioner Rigos. In the course of the
deliberations, it was further expressly made clear, specially with regard to Commissioner Joaquin F.
Bernas' accepted amendment to the amendment of Commissioner Rigos, that the salaries of members
of the Judiciary would be subject to the general income tax applied to all taxpayers.

This intent was somehow and inadvertently not clearly set forth in the final text of the Constitution as
approved and ratified in February, 1987 (infra, pp. 7-8). Although the intent may have been obscured by
the failure to include in the General Provisions a proscription against exemption of any public officer or
employee, including constitutional officers, from payment of income tax, the Court since then has
authorized the continuation of the deduction of the withholding tax from the salaries of the members of
the Supreme Court, as well as from the salaries of all other members of the Judiciary. The Court hereby
makes of record that it had then discarded the ruling in Perfecto vs. Meer and Endencia vs. David,
infra, that declared the salaries of members of the Judiciary exempt from payment of the income tax
and considered such payment as a diminution of their salaries during their continuance in office. The
Court hereby reiterates that the salaries of Justices and Judges are properly subject to a general income
tax law applicable to all income earners and that the payment of such income tax by Justices and Judges
does not fall within the constitutional protection against decrease of their salaries during their
continuance in office.

A comparison of the Constitutional provisions involved is called for. The 1935 Constitution provided:

... (The members of the Supreme Court and all judges of inferior courts) shall receive such compensation
as may be fixed by law, which shall not be diminished during their continuance in office ... 1 (Emphasis
supplied).

Under the 1973 Constitution, the same provision read:

The salary of the Chief Justice and of the Associate Justices of the Supreme court, and of judges of
inferior courts shall be fixed by law, which shall not be decreased during their continuance in office.
... 2 (Emphasis ours).
And in respect of income tax exemption, another provision in the same 1973 Constitution specifically
stipulated:

No salary or any form of emolument of any public officer or employee, including constitutional officers,
shall be exempt from payment of income tax. 3

The provision in the 1987 Constitution, which petitioners rely on, reads:

The salary of the Chief Justice and of the Associate Justices of the Supreme Court, and of judges of lower
courts shall be fixed by law. During their continuance in office, their salary shall not
be decreased. 4(Emphasis supplied).

The 1987 Constitution does not contain a provision similar to Section 6, Article XV of the 1973
Constitution, for which reason, petitioners claim that the intent of the framers is to revert to the original
concept of "non-diminution "of salaries of judicial officers.

The deliberations of the 1986 Constitutional Commission relevant to Section 10, Article VIII, negate such
contention.

The draft proposal of Section 10, Article VIII, of the 1987 Constitution read:

Section 13. The salary of the Chief Justice and the Associate Justices of the Supreme Court and of judges
of the lower courts shall be fixed by law. During their continuance in office, their salary shall not be
diminished nor subjected to income tax. Until the National Assembly shall provide otherwise, the Chief
Justice shall receive an annual salary of _____________ and each Associate Justice ______________
pesos. 5(Emphasis ours)

During the debates on the draft Article (Committee Report No. 18), two Commissioners presented their
objections to the provision on tax exemption, thus:

MS. AQUINO. Finally, on the matter of exemption from tax of the salary of justices, does this not violate
the principle of the uniformity of taxation and the principle of equal protection of the law? After all, tax
is levied not on the salary but on the combined income, such that when the judge receives a salary and
it is comingled with the other income, we tax the income, not the salary. Why do we have to give special
privileges to the salary of justices?

MR. CONCEPCION. It is the independence of the judiciary. We prohibit the increase or decrease of their
salary during their term. This is an indirect way of decreasing their salary and affecting the
independence of the judges.

MS. AQUINO. I appreciate that to be in the nature of a clause to respect tenure, but the special privilege
on taxation might, in effect, be a violation of the principle of uniformity in taxation and the equal
protection clause. 6

xxx xxx xxx

MR. OPLE. x x x

Of course, we share deeply the concern expressed by the sponsor, Commissioner Roberto Concepcion,
for whom we have the highest respect, to surround the Supreme Court and the judicial system as a
whole with the whole armor of defense against the executive and legislative invasion of their
independence. But in so doing, some of the citizens outside, especially the humble government
employees, might say that in trying to erect a bastion of justice, we might end up with the fortress of
privileges, an island of extra territoriality under the Republic of the Philippines, because a good number
of powers and rights accorded to the Judiciary here may not be enjoyed in the remotest degree by other
employees of the government.

An example is the exception from income tax, which is a kind of economic immunity, which is, of course,
denied to the entire executive department and the legislative. 7

And during the period of amendments on the draft Article, on July 14, 1986, Commissioner Cirilo A.
Rigos proposed that the term "diminished" be changed to "decreased" and that the words "nor
subjected to income tax" be deleted so as to "give substance to equality among the three branches in
the government.

Commissioner Florenz D. Regalado, on behalf of the Committee on the Judiciary, defended the original
draft and referred to the ruling of this Court in Perfecto vs. Meer 8 that "the independence of the judges
is of far greater importance than any revenue that could come from taxing their salaries." Commissioner
Rigos then moved that the matter be put to a vote. Commissioner Joaquin G. Bernas stood up "in
support of an amendment to the amendment with the request for a modification of the amendment,"
as follows:

FR. BERNAS. Yes. I am going to propose an amendment to the amendment saying that it is not enough
to drop the phrase "shall not be subjected to income tax," because if that is all that the Gentleman will
do, then he will just fall back on the decision in Perfecto vs. Meer and in Dencia vs. David [should be
Endencia and Jugo vs. David, etc., 93 Phil. 696[ which excludes them from income tax, but rather I would
propose that the statement will read: "During their continuance in office, their salary shall not be
diminished BUT MAY BE SUBJECT TO GENERAL INCOME TAX."IN support of this position, I would say that
the argument seems to be that the justice and judges should not be subjected to income tax because
they already gave up the income from their practice. That is true also of Cabinet members and all other
employees. And I know right now, for instance, there are many people who have accepted employment
in the government involving a reduction of income and yet are still subject to income tax. So, they are
not the only citizens whose income is reduced by accepting service in government.

Commissioner Rigos accepted the proposed amendment to the amendment. Commissioner Rustico F.
de los Reyes, Jr. then moved for a suspension of the session. Upon resumption, Commissioner Bernas
announced:

During the suspension, we came to an understanding with the original proponent, Commissioner Rigos,
that his amendment on page 6,. line 4 would read: "During their continuance in office, their salary shall
not be DECREASED."But this is on the understanding that there will be a provision in the Constitution
similar to Section 6 of Article XV, the General Provisions of the 1973 Constitution, which says:

No salary or any form of emolument of any public officer or employee, including constitutional officers,
shall be exempt from payment of income tax.

So, we put a period (.) after "DECREASED" on the understanding that the salary of justices is subject to
tax.

When queried about the specific Article in the General Provisions on non-exemption from tax of salaries
of public officers, Commissioner Bernas replied:

FR BERNAS. Yes, I do not know if such an article will be found in the General Provisions. But at any rate,
when we put a period (.) after "DECREASED," it is on the understanding that the doctrine in Perfecto vs.
Meer and Dencia vs. David will not apply anymore.

The amendment to the original draft, as discussed and understood, was finally approved without
objection.

THE PRESIDING OFFICER (Mr. Bengzon). The understanding, therefore, is that there will be a provision
under the Article on General Provisions. Could Commissioner Rosario Braid kindly take note that the
salaries of officials of the government including constitutional officers shall not be exempt from income
tax? The amendment proposed herein and accepted by the Committee now reads as follows: "During
their continuance in office, their salary shall not be DECREASED"; and the phrase "nor subjected to
income tax" is deleted.9

The debates, interpellations and opinions expressed regarding the constitutional provision in question
until it was finally approved by the Commission disclosed that the true intent of the framers of the 1987
Constitution, in adopting it, was to make the salaries of members of the Judiciary taxable. The
ascertainment of that intent is but in keeping with the fundamental principle of constitutional
construction that the intent of the framers of the organic law and of the people adopting it should be
given effect.10 The primary task in constitutional construction is to ascertain and thereafter assure the
realization of the purpose of the framers and of the people in the adoption of the Constitution.11it may
also be safely assumed that the people in ratifying the Constitution were guided mainly by the
explanation offered by the framers.12 1avvphi1

Besides, construing Section 10, Articles VIII, of the 1987 Constitution, which, for clarity, is again
reproduced hereunder:

The salary of the Chief Justice and of the Associate Justices of the Supreme Court, and of judges of lower
courts shall be fixed by law. During their continuance in office, their salary shall not be decreased.
(Emphasis supplied).

it is plain that the Constitution authorizes Congress to pass a law fixing another rate of compensation of
Justices and Judges but such rate must be higher than that which they are receiving at the time of
enactment, or if lower, it would be applicable only to those appointed after its approval. It would be a
strained construction to read into the provision an exemption from taxation in the light of the discussion
in the Constitutional Commission.

With the foregoing interpretation, and as stated heretofore, the ruling that "the imposition of income
tax upon the salary of judges is a dimunition thereof, and so violates the Constitution" in Perfecto vs.
Meer,13 as affirmed in Endencia vs. David 14 must be declared discarded. The framers of the fundamental
law, as the alter ego of the people, have expressed in clear and unmistakable terms the meaning and
import of Section 10, Article VIII, of the 1987 Constitution that they have adopted

Stated otherwise, we accord due respect to the intent of the people, through the discussions and
deliberations of their representatives, in the spirit that all citizens should bear their aliquot part of the
cost of maintaining the government and should share the burden of general income taxation equitably.

WHEREFORE, the instant petition for Prohibition is hereby dismissed.

Teehankee, C.J., Fernan, Narvasa, Gutierrez, Jr., Cruz, Paras, Feliciano, Gancayco, Padilla, Bidin,
Sarmiento and Cortes, JJ., concur.
Yap, J., is on leave.

FACTS:

• Sps. Arthur Henderson and Marie Henderson filed their annual income tax with the BIR. Arthur is
president of American International Underwriters for the Philippines, Inc., which is a domestic
corporation engaged in the business of general non-life insurance, and represents a group of American
insurance companies engaged in the business of general non-life insurance.

• The BIR demanded payment for alleged deficiency taxes. In their computation, the BIR included as part
of taxable income: 1) Arthur’s allowances for rental, residential expenses, subsistence, water, electricity
and telephone expenses 2) entrance fee to the Marikina Gun and Country Club which was paid by his
employer for his account and 3) travelling allowance of his wife

• The taxpayers justifications are as follows:

1) as to allowances for rental and utilities, Arthur did not receive money for the allowances. Instead, the
apartment is furnished and paid for by his employer-corporation (the mother company of American
International), for the employer corporation’s purposes. The spouses had no choice but to live in the
expensive apartment, since the company used it to entertain guests, to accommodate officials, and to
entertain customers. According to taxpayers, only P 4,800 per year is the reasonable amount that the
spouses would be spending on rental if they were not required to live in those apartments. Thus, it is the
amount they deem is subject to tax. The excess is to be treated as expense of the company.
2) The entrance fee should not be considered income since it is an expense of his employer, and
membership therein is merely incidental to his duties of increasing and sustaining the business of his
employer.

3) His wife merely accompanied him to New York on a business trip as his secretary, and at the
employer-corporation’s request, for the wife to look at details of the plans of a building that his
employer intended to construct. Such must not be considered taxable income.

• The Collector of Internal Revenue merely allowed the entrance fee as nontaxable. The rent expense
and travel expenses were still held to be taxable. The Court of Tax Appeals ruled in favor of the
taxpayers, that such expenses must not be considered part of taxable income. Letters of the wife while
in New York concerning the proposed building were presented as evidence.

ISSUE: Whether or not the rental allowances and travel allowances furnished and given by the
employer-corporation are part of taxable income?

HELD: NO. Such claims are substantially supported by evidence.

These claims are therefore NOT part of taxable income. No part of the allowances in question
redounded to their personal benefit, nor were such amounts retained by them. These bills were paid
directly by the employer-corporation to the creditors. The rental expenses and subsistence allowances
are to be considered not subject to income tax. Arthur’s high executive position and social standing,
demanded and compelled the couple to live in a more spacious and expensive quarters. Such
‘subsistence allowance’ was a SEPARATE account from the account for salaries and wages of employees.
The company did not charge rentals as deductible from the salaries of the employees. These expenses
are COMPANY EXPENSES, not income by employees which are subject to tax.

Commissioner v. Smith, 324 U.S. 177 (1945)

Commissioner of Internal Revenue v. Smith

No. 371

Argued January 30, 31, 1945

Decided February 26, 1945

324 U.S. 177

CERTIORARI TO THE CIRCUIT COURT OF APPEALS

FOR THE NINTH CIRCUIT

Syllabus

An employer gave to its employee as compensation for his services an option to purchase shares of
stock at a price not less than the then value of the stock. The option had no value at that time, and the
compensation contemplated by the parties was the transfer to the employee of the shares of stock
after their value had increased to more than the option price.

Held, under § 22(a) of the Revenue Act of 1938 and of the Internal Revenue Code, the employee
received "compensation for personal service," and hence taxable income in each year in which stock
was acquired, through effective exercise of the option in that year, in the amount of the difference
between the pt.ion price and the then market value of the stock. P.324 U. S. 181.

142 F.2d 818, reversed.

Certiorari, 323 U.S. 696, to review the reversal of a decision of the Tax Court which sustained the
Commissioner's determination of a deficiency in income tax.

MR. CHIEF JUSTICE STONE delivered the opinion of the Court.

Respondent's employer gave to him, as compensation for his services, an option to purchase from the
employer certain shares of stock of another corporation at a price not less than the then value of the
stock. In two later

Page 324 U. S. 178

tax years, when the market value of the stock was greater than the option price, respondent exercised
the option, purchasing large amounts of the stock in each year. The question for decision is whether
the difference between the market value and the option price of the stock was compensation for
personal services of the employee, taxable as income in the years when he received the stock, under §
22(a) of the Revenue Act of 1938, c. 289, 52 Stat. 447, and § 22(a) of the Internal Revenue Code, 26
U.S.C. § 22(a).

Upon a petition to review the Commissioner's finding of a tax deficiency against respondent for those
years, the Tax Court sustained the Commissioner. The Court of Appeals for the Ninth Circuit reversed,
142 F.2d 818, holding that there was no finding, and no evidence to support a finding, that the option
was intended to enable respondent to make a "bargain purchase," or that the stock was issued to him
as compensation for services. It concluded that the exercise of the option was a mere purchase of a
capital investment which could result in taxable income only upon sale of the stock. We granted
certiorari, 323 U.S. 696, on a petition which asserted conflict of the decision below with the decision
of the Court of Appeals for the Sixth Circuit in Connolly's Estate v. Commissioner, 135 F.2d 64.

The Tax Court found that, for many years and at all relevant times, respondent was employed by the
Western Cooperage Company. In 1934, Western took over the management of the Hawley Pulp and
Paper Co. pursuant to a plan for its reorganization. Hawley was then in financial difficulties, with an
indebtedness amounting to $2,790,150. Under its contract with Hawley, Western was to retire
annually a certain amount of Hawley's indebtedness. In the event of success in this undertaking, and
when the amount of Hawley's indebtedness had been reduced by the sum of $1,400,000, Western
was to receive

Page 324 U. S. 179

specified amounts of the Hawley Company's capital stock as compensation for the services thus
rendered.

Respondent, in the course of his employment by Western, was active in the reorganization of the
Hawley Company. As compensation for his services, the president of Western, in December, 1934,
gave respondent an oral option to purchase a part of the Hawley stock, to be acquired by Western
under its contract. This action was confirmed by resolution of the Board of Directors of Western
pursuant to which Western, as of December 10, 1934, and "in consideration of services rendered" by
respondent prior to that date, agreed in writing to sell to respondent, at his option at 10 cents a share,
a specified proportion of such shares of common stock as it might be entitled to receive under its
contract with Hawley. On March 18, 1938, Western became entitled to the stipulated number of
shares of the Hawley stock as provided by the contract with Hawley. In that and the following year,
respondent, by the exercise of his option, acquired from Western large amounts of the stock on
payment of the option price.

The Tax Court found that, at the date of the option, the market price of the stock did not exceed the
option price, but that, in 1938, the market value of the stock then acquired by respondent exceeded
its option price by $81,021, and the value of that acquired in 1939 exceeded the option price by
$71,663. The court found from the option itself, the resolution of Western's Board of Directors, and
from petitioner's own testimony, that "Western gave the option to petitioner [respondent here] as
compensation for services rendered in effecting the reorganization plan of Hawley." It held that the
excess of the market value of the shares over the option price in the years when the shares were
received by respondent was compensation for his services, taxable as income in those years.

Since the Tax Court found that the market price of the stock on the date of the option did not exceed
the option

Page 324 U. S. 180

price, it is evident that its finding that the option was given as compensation for respondent's services
had reference to the compensation to be derived from exercise of the option after the anticipated
advance in market price of the stock. Respondent testified that, if the option could have been sold at
the time he received it, it would have been for only a "negligible" or "nominal" amount. He has never
contended that the option itself had value when given, and there was no finding by the Tax Court that
it then had value. The Tax Court, in stating the principle which it deemed applicable to the present
case, quoted from Estate of Edward J. Connolly, 45 B.T.A. 374, as follows: "If the options had never
been exercised, the optionees would never have received any additional compensation." The option
could be exercised only when Western's contract with Hawley had been successfully performed by the
reduction of a large part of Hawley's indebtedness, which would result in an increase in the value of
Hawley's capital stock to be received by Western subject to respondent's option. Moreover, the Tax
Court concluded as a matter of law that the facts which it found, and which we have detailed, brought
the case, for the tax year 1938, within the provisions of § 22(a) of the Revenue Act of 1938, and of the
interpretative Treasury Regulations 101, Art. 22(a)-1, and for the tax year 1939, within the identical
provisions of § 22(a) of the Internal Revenue Code, and Treasury Regulations 103, Art. 19.22(a)-1.

Section 22(a) of the Revenue Act defines "gross income" subject to the Act as including "gains, profits,
and income derived from salaries, wages, or compensation for personal service . . of whatever kind
and in whatever form paid. . . ." Treasury Regulations 101, Art. 22(a)-1 provides:

"If property is transferred . . . by an employer to an employee, for an amount substantially less than
its fair market value, regardless of whether the transfer is in

Page 324 U. S. 181

the guise of a sale or exchange, such . . . employee shall include in gross income the difference
between the amount paid for the property and the amount of its fair market value to the extent that
such difference is in the nature of (1) compensation for services rendered. . . ."

Section 22(a) of the Revenue Act is broad enough to include in taxable income any economic or
financial benefit conferred on the employee as compensation, whatever the form or mode by which it
is effected. See Old Colony Trust Co. v. Commissioner, 279 U. S. 716, 279 U. S. 729. The regulation
specifically includes in income, property "transferred . . . by an employer to an employee, for an
amount substantially less than its fair market value," even though the transfer takes the form of a sale
or exchange, to the extent that the employee receives compensation.

In certain aspects an option may be spoken of as "property" in the hands of the option holder. Cf.
Helvering v. San Joaquin Fruit & Investment Co., 297 U. S. 496, 297 U. S. 498; Shuster v. Helvering, 121
F.2d 643, 645. When the option price is less than the market price of the property for the purchase of
which the option is given, it may have present value and may be found to be itself compensation for
services rendered. But it is plain that, in the circumstances of the present case, the option, when
given, did not operate to transfer any of the shares of stock from the employer to the employee
within the meaning of § 22(a) and Art. 22(a)-1. Cf. Palmer v. Commissioner, 302 U. S. 63, 302 U. S. 71.
And, as the option was not found to have any market value when given, it could not itself operate to
compensate respondent. It could do so only as it might be the means of securing the transfer of the
shares of stock from the employer to the employee at a price less than their market value, or possibly,
which we do not decide, as the option might be sold when that disparity in value existed. Hence, the
compensation for respondent's services, which the parties contemplated, plainly was not confined to
the mere

Page 324 U. S. 182

delivery to respondent of an option of no present value, but included the compensation obtainable by
the exercise of the option given for that purpose. It, of course, does not follow that, in other
circumstances not here present, the option itself, rather than the proceeds of its exercise, could not
be found to be the only intended compensation.

The Tax Court thus found that the option was given to respondent as compensation for services, and
implicitly that the compensation referred to was the excess in value of the shares of stock over the
option price whenever the option was exercised. From these facts it concluded that the compensation
was taxable as such by the provisions of the applicable Revenue Acts and regulations. We find no
basis for disturbing its findings, and we conclude it correctly applied the law to the facts found. Its
decision is affirmed, and the judgment of the Court of Appeals below, reversing it, is

Reversed.