G.R. No.

L-9996 October 15, 1957

EUFEMIA EVANGELISTA, MANUELA EVANGELISTA, and FRANCISCA EVANGELISTA, petitioners,

vs.
THE COLLECTOR OF INTERNAL REVENUE and THE COURT OF TAX APPEALS, respondents.

Santiago F. Alidio and Angel S. Dakila, Jr., for petitioner.

Office of the Solicitor General Ambrosio Padilla, Assistant Solicitor General Esmeraldo Umali and Solicitor
Felicisimo R. Rosete for Respondents.

CONCEPCION, J.:

This is a petition filed by Eufemia Evangelista, Manuela Evangelista and Francisca Evangelista, for review of a
decision of the Court of Tax Appeals, the dispositive part of which reads:

FOR ALL THE FOREGOING, we hold that the petitioners are liable for the income tax, real estate
dealer's tax and the residence tax for the years 1945 to 1949, inclusive, in accordance with the
respondent's assessment for the same in the total amount of P6,878.34, which is hereby affirmed and
the petition for review filed by petitioner is hereby dismissed with costs against petitioners.

It appears from the stipulation submitted by the parties:

1. That the petitioners borrowed from their father the sum of P59,1400.00 which amount together with
their personal monies was used by them for the purpose of buying real properties,.

2. That on February 2, 1943, they bought from Mrs. Josefina Florentino a lot with an area of 3,713.40 sq.
m. including improvements thereon from the sum of P100,000.00; this property has an assessed value of
P57,517.00 as of 1948;

3. That on April 3, 1944 they purchased from Mrs. Josefa Oppus 21 parcels of land with an aggregate
area of 3,718.40 sq. m. including improvements thereon for P130,000.00; this property has an assessed
value of P82,255.00 as of 1948;

4. That on April 28, 1944 they purchased from the Insular Investments Inc., a lot of 4,353 sq. m.
including improvements thereon for P108,825.00. This property has an assessed value of P4,983.00 as
of 1948;

5. That on April 28, 1944 they bought form Mrs. Valentina Afable a lot of 8,371 sq. m. including
improvements thereon for P237,234.34. This property has an assessed value of P59,140.00 as of 1948;

6. That in a document dated August 16, 1945, they appointed their brother Simeon Evangelista to
'manage their properties with full power to lease; to collect and receive rents; to issue receipts therefor;
in default of such payment, to bring suits against the defaulting tenants; to sign all letters, contracts, etc.,
for and in their behalf, and to endorse and deposit all notes and checks for them;

7. That after having bought the above-mentioned real properties the petitioners had the same rented or
leases to various tenants;

8. That from the month of March, 1945 up to an including December, 1945, the total amount collected as
rents on their real properties was P9,599.00 while the expenses amounted to P3,650.00 thereby leaving
them a net rental income of P5,948.33;

9. That on 1946, they realized a gross rental income of in the sum of P24,786.30, out of which amount
was deducted in the sum of P16,288.27 for expenses thereby leaving them a net rental income of
P7,498.13;

1
 10. That in 1948, they realized a gross rental income of P17,453.00 out of the which amount was
deducted the sum of P4,837.65 as expenses, thereby leaving them a net rental income of P12,615.35.

It further appears that on September 24, 1954 respondent Collector of Internal Revenue demanded the payment
of income tax on corporations, real estate dealer's fixed tax and corporation residence tax for the years 1945-
1949, computed, according to assessment made by said officer, as follows:

INCOME TAXES

1945 14.84

1946 1,144.71

1947 10.34

1948 1,912.30

1949 1,575.90

Total including surcharge and P6,157.09

compromise

REAL ESTATE DEALER'S FIXED TAX

1946 P37.50

1947 150.00

1948 150.00

1949 150.00

Total including penalty P527.00

RESIDENCE TAXES OF CORPORATION

1945 P38.75

1946 38.75

1947 38.75

1948 38.75

1949 38.75

Total including surcharge P193.75

TOTAL TAXES DUE P6,878.34.

Said letter of demand and corresponding assessments were delivered to petitioners on December 3, 1954,
whereupon they instituted the present case in the Court of Tax Appeals, with a prayer that "the decision of the
respondent contained in his letter of demand dated September 24, 1954" be reversed, and that they be absolved
from the payment of the taxes in question, with costs against the respondent.

After appropriate proceedings, the Court of Tax Appeals the above-mentioned decision for the respondent, and
a petition for reconsideration and new trial having been subsequently denied, the case is now before Us for
review at the instance of the petitioners.

2
The issue in this case whether petitioners are subject to the tax on corporations provided for in section 24 of
Commonwealth Act. No. 466, otherwise known as the National Internal Revenue Code, as well as to the
residence tax for corporations and the real estate dealers fixed tax. With respect to the tax on corporations, the
issue hinges on the meaning of the terms "corporation" and "partnership," as used in section 24 and 84 of said
Code, the pertinent parts of which read:

SEC. 24. Rate of tax on corporations.—There shall be levied, assessed, collected, and paid annually
upon the total net income received in the preceding taxable year from all sources by every corporation
organized in, or existing under the laws of the Philippines, no matter how created or organized but not
including duly registered general co-partnerships (compañias colectivas), a tax upon such income equal
to the sum of the following: . . .

SEC. 84 (b). The term 'corporation' includes partnerships, no matter how created or organized, joint-
stock companies, joint accounts (cuentas en participacion), associations or insurance companies, but
does not include duly registered general copartnerships. (compañias colectivas).

Article 1767 of the Civil Code of the Philippines provides:

By the contract of partnership two or more persons bind themselves to contribute money, properly, or
industry to a common fund, with the intention of dividing the profits among themselves.

Pursuant to the article, the essential elements of a partnership are two, namely: (a) an agreement to contribute
money, property or industry to a common fund; and (b) intent to divide the profits among the contracting parties.
The first element is undoubtedly present in the case at bar, for, admittedly, petitioners have agreed to, and did,
contribute money and property to a common fund. Hence, the issue narrows down to their intent in acting as
they did. Upon consideration of all the facts and circumstances surrounding the case, we are fully satisfied that
their purpose was to engage in real estate transactions for monetary gain and then divide the same among
themselves, because:

1. Said common fund was not something they found already in existence. It was not property inherited by
them pro indiviso. They created it purposely. What is more they jointly borrowed a substantial portion
thereof in order to establish said common fund.

2. They invested the same, not merely not merely in one transaction, but in a series of transactions. On
February 2, 1943, they bought a lot for P100,000.00. On April 3, 1944, they purchased 21 lots for
P18,000.00. This was soon followed on April 23, 1944, by the acquisition of another real estate for
P108,825.00. Five (5) days later (April 28, 1944), they got a fourth lot for P237,234.14. The number of
lots (24) acquired and transactions undertaken, as well as the brief interregnum between each,
particularly the last three purchases, is strongly indicative of a pattern or common design that was not
limited to the conservation and preservation of the aforementioned common fund or even of the property
acquired by the petitioners in February, 1943. In other words, one cannot but perceive a character of
habitually peculiar to business transactions engaged in the purpose of gain.

3. The aforesaid lots were not devoted to residential purposes, or to other personal uses, of petitioners
herein. The properties were leased separately to several persons, who, from 1945 to 1948 inclusive,
paid the total sum of P70,068.30 by way of rentals. Seemingly, the lots are still being so let, for
petitioners do not even suggest that there has been any change in the utilization thereof.

4. Since August, 1945, the properties have been under the management of one person, namely Simeon
Evangelista, with full power to lease, to collect rents, to issue receipts, to bring suits, to sign letters and
contracts, and to indorse and deposit notes and checks. Thus, the affairs relative to said properties have
been handled as if the same belonged to a corporation or business and enterprise operated for profit.

5. The foregoing conditions have existed for more than ten (10) years, or, to be exact, over fifteen (15)
years, since the first property was acquired, and over twelve (12) years, since Simeon Evangelista
became the manager.

3
 6. Petitioners have not testified or introduced any evidence, either on their purpose in creating the set up
already adverted to, or on the causes for its continued existence. They did not even try to offer an
explanation therefor.

Although, taken singly, they might not suffice to establish the intent necessary to constitute a partnership, the
collective effect of these circumstances is such as to leave no room for doubt on the existence of said intent in
petitioners herein. Only one or two of the aforementioned circumstances were present in the cases cited by
petitioners herein, and, hence, those cases are not in point.

Petitioners insist, however, that they are mere co-owners, not copartners, for, in consequence of the acts
performed by them, a legal entity, with a personality independent of that of its members, did not come into
existence, and some of the characteristics of partnerships are lacking in the case at bar. This pretense was
correctly rejected by the Court of Tax Appeals.

To begin with, the tax in question is one imposed upon "corporations", which, strictly speaking, are distinct and
different from "partnerships". When our Internal Revenue Code includes "partnerships" among the entities
subject to the tax on "corporations", said Code must allude, therefore, to organizations which are not necessarily
"partnerships", in the technical sense of the term. Thus, for instance, section 24 of said Code exempts from the
aforementioned tax "duly registered general partnerships which constitute precisely one of the most typical forms
of partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term corporation
includes partnerships, no matter how created or organized." This qualifying expression clearly indicates that a
joint venture need not be undertaken in any of the standard forms, or in conformity with the usual requirements
of the law on partnerships, in order that one could be deemed constituted for purposes of the tax on
corporations. Again, pursuant to said section 84(b), the term "corporation" includes, among other, joint accounts,
(cuentas en participation)" and "associations," none of which has a legal personality of its own, independent of
that of its members. Accordingly, the lawmaker could not have regarded that personality as a condition essential
to the existence of the partnerships therein referred to. In fact, as above stated, "duly registered general
copartnerships" — which are possessed of the aforementioned personality — have been expressly excluded by
law (sections 24 and 84 [b] from the connotation of the term "corporation" It may not be amiss to add that
petitioners' allegation to the effect that their liability in connection with the leasing of the lots above referred to,
under the management of one person — even if true, on which we express no opinion — tends to increase the
similarity between the nature of their venture and that corporations, and is, therefore, an additional argument in
favor of the imposition of said tax on corporations.

Under the Internal Revenue Laws of the United States, "corporations" are taxed differently from "partnerships".
By specific provisions of said laws, such "corporations" include "associations, joint-stock companies and
insurance companies." However, the term "association" is not used in the aforementioned laws.

. . . in any narrow or technical sense. It includes any organization, created for the transaction of designed
affairs, or the attainment of some object, which like a corporation, continues notwithstanding that its
members or participants change, and the affairs of which, like corporate affairs, are conducted by a
single individual, a committee, a board, or some other group, acting in a representative capacity. It is
immaterial whether such organization is created by an agreement, a declaration of trust, a statute, or
otherwise. It includes a voluntary association, a joint-stock corporation or company, a 'business' trusts a
'Massachusetts' trust, a 'common law' trust, and 'investment' trust (whether of the fixed or the
management type), an interinsuarance exchange operating through an attorney in fact, a partnership
association, and any other type of organization (by whatever name known) which is not, within the
meaning of the Code, a trust or an estate, or a partnership. (7A Mertens Law of Federal Income
Taxation, p. 788; emphasis supplied.).

Similarly, the American Law.

. . . provides its own concept of a partnership, under the term 'partnership 'it includes not only a
partnership as known at common law but, as well, a syndicate, group, pool, joint venture or other
unincorporated organizations which carries on any business financial operation, or venture, and which is
not, within the meaning of the Code, a trust, estate, or a corporation. . . (7A Merten's Law of Federal
Income taxation, p. 789; emphasis supplied.)

4
 The term 'partnership' includes a syndicate, group, pool, joint venture or other unincorporated
organization, through or by means of which any business, financial operation, or venture is carried on, . .
.. ( 8 Merten's Law of Federal Income Taxation, p. 562 Note 63; emphasis supplied.) .

For purposes of the tax on corporations, our National Internal Revenue Code, includes these partnerships —
with the exception only of duly registered general copartnerships — within the purview of the term
"corporation." It is, therefore, clear to our mind that petitioners herein constitute a partnership, insofar as said
Code is concerned and are subject to the income tax for corporations.

As regards the residence of tax for corporations, section 2 of Commonwealth Act No. 465 provides in part:

Entities liable to residence tax.-Every corporation, no matter how created or organized, whether
domestic or resident foreign, engaged in or doing business in the Philippines shall pay an annual
residence tax of five pesos and an annual additional tax which in no case, shall exceed one thousand
pesos, in accordance with the following schedule: . . .

The term 'corporation' as used in this Act includes joint-stock company, partnership, joint account
(cuentas en participacion), association or insurance company, no matter how created or organized.
(emphasis supplied.)

Considering that the pertinent part of this provision is analogous to that of section 24 and 84 (b) of our National
Internal Revenue Code (commonwealth Act No. 466), and that the latter was approved on June 15, 1939, the
day immediately after the approval of said Commonwealth Act No. 465 (June 14, 1939), it is apparent that the
terms "corporation" and "partnership" are used in both statutes with substantially the same meaning.
Consequently, petitioners are subject, also, to the residence tax for corporations.

Lastly, the records show that petitioners have habitually engaged in leasing the properties above mentioned for
a period of over twelve years, and that the yearly gross rentals of said properties from June 1945 to 1948 ranged
from P9,599 to P17,453. Thus, they are subject to the tax provided in section 193 (q) of our National Internal
Revenue Code, for "real estate dealers," inasmuch as, pursuant to section 194 (s) thereof:

'Real estate dealer' includes any person engaged in the business of buying, selling, exchanging, leasing,
or renting property or his own account as principal and holding himself out as a full or part time dealer in
real estate or as an owner of rental property or properties rented or offered to rent for an aggregate
amount of three thousand pesos or more a year. . . (emphasis supplied.)

Wherefore, the appealed decision of the Court of Tax appeals is hereby affirmed with costs against the
petitioners herein. It is so ordered.

Bengzon, Paras, C.J., Padilla, Reyes, A., Reyes, J.B.L., Endencia and Felix, JJ., concur.

BAUTISTA ANGELO, J., concurring:

I agree with the opinion that petitioners have actually contributed money to a common fund with express purpose
of engaging in real estate business for profit. The series of transactions which they had undertaken attest to this.
This appears in the following portion of the decision:

2. They invested the same, not merely in one transaction, but in a series of transactions. On February 2,
1943, they bought a lot for P100,000. On April 3, 1944, they purchase 21 lots for P18,000. This was
soon followed on April 23, 1944, by the acquisition of another real state for P108,825. Five (5) days later
(April 28, 1944), they got a fourth lot for P237,234.14. The number of lots (24) acquired and transactions
undertaken, as well as the brief interregnum between each, particularly the last three purchases, is
strongly indicative of a pattern or common design that was not limited to the conservation and
preservation of the aforementioned common fund or even of the property acquired by the petitioner in

5
 February, 1943, In other words, we cannot but perceive a character of habitually peculiar
to business transactions engaged in for purposes of gain.

I wish however to make to make the following observation:

Article 1769 of the new Civil Code lays down the rule for determining when a transaction should be deemed a
partnership or a co-ownership. Said article paragraphs 2 and 3, provides:

(2) Co-ownership or co-possession does not of itself establish a partnership, whether such co-owners or
co-possessors do or do not share any profits made by the use of the property;

(3) The sharing of gross returns does not of itself establish partnership, whether or not the person
sharing them have a joint or common right or interest in any property from which the returns are derived;

From the above it appears that the fact that those who agree to form a co-ownership shared or do not share any
profits made by the use of property held in common does not convert their venture into a partnership. Or the
sharing of the gross returns does not of itself establish a partnership whether or not the persons sharing therein
have a joint or common right or interest in the property. This only means that, aside from the circumstance of
profit, the presence of other elements constituting partnership is necessary, such as the clear intent to form a
partnership, the existence of a judicial personality different from that of the individual partners, and the freedom
to transfer or assign any interest in the property by one with the consent of the others (Padilla, Civil Code of the
Philippines Annotated, Vol. I, 1953 ed., pp. 635- 636).

It is evident that an isolated transaction whereby two or more persons contribute funds to buy certain real estate
for profit in the absence of other circumstances showing a contrary intention cannot be considered a partnership.

Persons who contribute property or funds for a common enterprise and agree to share the gross returns
of that enterprise in proportion to their contribution, but who severally retain the title to their respective
contribution, are not thereby rendered partners. They have no common stock or capital, and no
community of interest as principal proprietors in the business itself which the proceeds derived.
(Elements of the law of Partnership by Floyd R. Mechem, 2n Ed., section 83, p. 74.)

A joint venture purchase of land, by two, does not constitute a copartnership in respect thereto; nor does
not agreement to share the profits and loses on the sale of land create a partnership; the parties are only
tenants in common. (Clark vs. Sideway, 142 U.S. 682, 12 S Ct. 327, 35 L. Ed., 1157.)

Where plaintiff, his brother, and another agreed to become owners of a single tract of reality, holding as
tenants in common, and to divide the profits of disposing of it, the brother and the other not being entitled
to share in plaintiff's commissions, no partnership existed as between the parties, whatever relation may
have been as to third parties. (Magee vs. Magee, 123 N. E. 6763, 233 Mass. 341.)

In order to constitute a partnership inter sese there must be: (a) An intent to form the same; (b) generally
a participating in both profits and losses; (c) and such a community of interest, as far as third persons
are concerned as enables each party to make contract, manage the business, and dispose of the whole
property. (Municipal Paving Co. vs Herring, 150 P. 1067, 50 Ill. 470.)

The common ownership of property does not itself create a partnership between the owners, though they
may use it for purpose of making gains; and they may, without becoming partners, agree among
themselves as to the management and use of such property and the application of the proceeds
therefrom. (Spurlock vs. Wilson, 142 S. W. 363, 160 No. App. 14.)

This is impliedly recognized in the following portion of the decision: "Although, taken singly, they might not
suffice to establish the intent necessary to constitute a partnership, the collective effect of these circumstances
(referring to the series of transactions) such as to leave no room for doubt on the existence of said intent in
petitioners herein."

6
G.R. No. L-19342 May 25, 1972

LORENZO T. OÑA and HEIRS OF JULIA BUÑALES, namely: RODOLFO B. OÑA, MARIANO B. OÑA, LUZ
B. OÑA, VIRGINIA B. OÑA and LORENZO B. OÑA, JR., petitioners,
vs.
THE COMMISSIONER OF INTERNAL REVENUE, respondent.

Orlando Velasco for petitioners.

Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete, and Special
Attorney Purificacion Ureta for respondent.

BARREDO, J.:p

Petition for review of the decision of the Court of Tax Appeals in CTA Case No. 617, similarly entitled as above, holding that petitioners have constituted an
unregistered partnership and are, therefore, subject to the payment of the deficiency corporate income taxes assessed against them by respondent
Commissioner of Internal Revenue for the years 1955 and 1956 in the total sum of P21,891.00, plus 5% surcharge and 1% monthly interest from December
15, 1958, subject to the provisions of Section 51 (e) (2) of the Internal Revenue Code, as amended by Section 8 of Republic Act No. 2343 and the costs of
the suit,1 as well as the resolution of said court denying petitioners' motion for reconsideration of said decision.

The facts are stated in the decision of the Tax Court as follows:

Julia Buñales died on March 23, 1944, leaving as heirs her surviving spouse, Lorenzo T. Oña
and her five children. In 1948, Civil Case No. 4519 was instituted in the Court of First Instance of
Manila for the settlement of her estate. Later, Lorenzo T. Oña the surviving spouse was
appointed administrator of the estate of said deceased (Exhibit 3, pp. 34-41, BIR rec.). On April
14, 1949, the administrator submitted the project of partition, which was approved by the Court
on May 16, 1949 (See Exhibit K). Because three of the heirs, namely Luz, Virginia and Lorenzo,
Jr., all surnamed Oña, were still minors when the project of partition was approved, Lorenzo T.
Oña, their father and administrator of the estate, filed a petition in Civil Case No. 9637 of the
Court of First Instance of Manila for appointment as guardian of said minors. On November 14,
1949, the Court appointed him guardian of the persons and property of the aforenamed minors
(See p. 3, BIR rec.).

The project of partition (Exhibit K; see also pp. 77-70, BIR rec.) shows that the heirs have
undivided one-half (1/2) interest in ten parcels of land with a total assessed value of P87,860.00,
six houses with a total assessed value of P17,590.00 and an undetermined amount to be
collected from the War Damage Commission. Later, they received from said Commission the
amount of P50,000.00, more or less. This amount was not divided among them but was used in
the rehabilitation of properties owned by them in common (t.s.n., p. 46). Of the ten parcels of
land aforementioned, two were acquired after the death of the decedent with money borrowed
from the Philippine Trust Company in the amount of P72,173.00 (t.s.n., p. 24; Exhibit 3, pp. 31-34
BIR rec.).

The project of partition also shows that the estate shares equally with Lorenzo T. Oña, the
administrator thereof, in the obligation of P94,973.00, consisting of loans contracted by the latter
with the approval of the Court (see p. 3 of Exhibit K; or see p. 74, BIR rec.).

Although the project of partition was approved by the Court on May 16, 1949, no attempt was
made to divide the properties therein listed. Instead, the properties remained under the
management of Lorenzo T. Oña who used said properties in business by leasing or selling them
and investing the income derived therefrom and the proceeds from the sales thereof in real
properties and securities. As a result, petitioners' properties and investments gradually increased
from P105,450.00 in 1949 to P480,005.20 in 1956 as can be gleaned from the following year-end
balances:

7
 Year Investment Land Building

Account Account Account

1949 — P87,860.00 P17,590.00

1950 P24,657.65 128,566.72 96,076.26

1951 51,301.31 120,349.28 110,605.11

1952 67,927.52 87,065.28 152,674.39

1953 61,258.27 84,925.68 161,463.83

1954 63,623.37 99,001.20 167,962.04

1955 100,786.00 120,249.78 169,262.52

1956 175,028.68 135,714.68 169,262.52

(See Exhibits 3 & K t.s.n., pp. 22, 25-26, 40, 50, 102-104)

From said investments and properties petitioners derived such incomes as profits from
installment sales of subdivided lots, profits from sales of stocks, dividends, rentals and interests
(see p. 3 of Exhibit 3; p. 32, BIR rec.; t.s.n., pp. 37-38). The said incomes are recorded in the
books of account kept by Lorenzo T. Oña where the corresponding shares of the petitioners in
the net income for the year are also known. Every year, petitioners returned for income tax
purposes their shares in the net income derived from said properties and securities and/or from
transactions involving them (Exhibit 3, supra; t.s.n., pp. 25-26). However, petitioners did not
actually receive their shares in the yearly income. (t.s.n., pp. 25-26, 40, 98, 100). The income
was always left in the hands of Lorenzo T. Oña who, as heretofore pointed out, invested them in
real properties and securities. (See Exhibit 3, t.s.n., pp. 50, 102-104).

On the basis of the foregoing facts, respondent (Commissioner of Internal Revenue) decided that
petitioners formed an unregistered partnership and therefore, subject to the corporate income
tax, pursuant to Section 24, in relation to Section 84(b), of the Tax Code. Accordingly, he
assessed against the petitioners the amounts of P8,092.00 and P13,899.00 as corporate income
taxes for 1955 and 1956, respectively. (See Exhibit 5, amended by Exhibit 17, pp. 50 and 86,
BIR rec.). Petitioners protested against the assessment and asked for reconsideration of the
ruling of respondent that they have formed an unregistered partnership. Finding no merit in
petitioners' request, respondent denied it (See Exhibit 17, p. 86, BIR rec.). (See pp. 1-4,
Memorandum for Respondent, June 12, 1961).

The original assessment was as follows:

1955

Net income as per investigation ................ P40,209.89

Income tax due thereon ............................... 8,042.00

25% surcharge .............................................. 2,010.50
Compromise for non-filing .......................... 50.00
Total ............................................................... P10,102.50

1956

Net income as per investigation ................ P69,245.23

8
 Income tax due thereon ............................... 13,849.00
25% surcharge .............................................. 3,462.25
Compromise for non-filing .......................... 50.00
Total ............................................................... P17,361.25

(See Exhibit 13, page 50, BIR records)

Upon further consideration of the case, the 25% surcharge was eliminated in line with the ruling
of the Supreme Court in Collector v. Batangas Transportation Co., G.R. No. L-9692, Jan. 6,
1958, so that the questioned assessment refers solely to the income tax proper for the years
1955 and 1956 and the "Compromise for non-filing," the latter item obviously referring to the
compromise in lieu of the criminal liability for failure of petitioners to file the corporate income tax
returns for said years. (See Exh. 17, page 86, BIR records). (Pp. 1-3, Annex C to Petition)

Petitioners have assigned the following as alleged errors of the Tax Court:

I.

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE PETITIONERS FORMED AN
UNREGISTERED PARTNERSHIP;

II.

THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE PETITIONERS WERE
CO-OWNERS OF THE PROPERTIES INHERITED AND (THE) PROFITS DERIVED FROM
TRANSACTIONS THEREFROM (sic);

III.

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT PETITIONERS WERE LIABLE
FOR CORPORATE INCOME TAXES FOR 1955 AND 1956 AS AN UNREGISTERED
PARTNERSHIP;

IV.

ON THE ASSUMPTION THAT THE PETITIONERS CONSTITUTED AN UNREGISTERED

PARTNERSHIP, THE COURT OF TAX APPEALS ERRED IN NOT HOLDING THAT THE
PETITIONERS WERE AN UNREGISTERED PARTNERSHIP TO THE EXTENT ONLY THAT
THEY INVESTED THE PROFITS FROM THE PROPERTIES OWNED IN COMMON AND THE
LOANS RECEIVED USING THE INHERITED PROPERTIES AS COLLATERALS;

V.

ON THE ASSUMPTION THAT THERE WAS AN UNREGISTERED PARTNERSHIP, THE

COURT OF TAX APPEALS ERRED IN NOT DEDUCTING THE VARIOUS AMOUNTS PAID BY
THE PETITIONERS AS INDIVIDUAL INCOME TAX ON THEIR RESPECTIVE SHARES OF THE
PROFITS ACCRUING FROM THE PROPERTIES OWNED IN COMMON, FROM THE
DEFICIENCY TAX OF THE UNREGISTERED PARTNERSHIP.

In other words, petitioners pose for our resolution the following questions: (1) Under the facts found by the Court
of Tax Appeals, should petitioners be considered as co-owners of the properties inherited by them from the
deceased Julia Buñales and the profits derived from transactions involving the same, or, must they be deemed
to have formed an unregistered partnership subject to tax under Sections 24 and 84(b) of the National Internal
Revenue Code? (2) Assuming they have formed an unregistered partnership, should this not be only in the
sense that they invested as a common fund the profits earned by the properties owned by them in common and
the loans granted to them upon the security of the said properties, with the result that as far as their respective
shares in the inheritance are concerned, the total income thereof should be considered as that of co-owners and

9
not of the unregistered partnership? And (3) assuming again that they are taxable as an unregistered
partnership, should not the various amounts already paid by them for the same years 1955 and 1956 as
individual income taxes on their respective shares of the profits accruing from the properties they owned in
common be deducted from the deficiency corporate taxes, herein involved, assessed against such unregistered
partnership by the respondent Commissioner?

Pondering on these questions, the first thing that has struck the Court is that whereas petitioners' predecessor in
interest died way back on March 23, 1944 and the project of partition of her estate was judicially approved as
early as May 16, 1949, and presumably petitioners have been holding their respective shares in their inheritance
since those dates admittedly under the administration or management of the head of the family, the widower and
father Lorenzo T. Oña, the assessment in question refers to the later years 1955 and 1956. We believe this point
to be important because, apparently, at the start, or in the years 1944 to 1954, the respondent Commissioner of
Internal Revenue did treat petitioners as co-owners, not liable to corporate tax, and it was only from 1955 that he
considered them as having formed an unregistered partnership. At least, there is nothing in the record indicating
that an earlier assessment had already been made. Such being the case, and We see no reason how it could be
otherwise, it is easily understandable why petitioners' position that they are co-owners and not unregistered co-
partners, for the purposes of the impugned assessment, cannot be upheld. Truth to tell, petitioners should find
comfort in the fact that they were not similarly assessed earlier by the Bureau of Internal Revenue.

The Tax Court found that instead of actually distributing the estate of the deceased among themselves pursuant
to the project of partition approved in 1949, "the properties remained under the management of Lorenzo T. Oña
who used said properties in business by leasing or selling them and investing the income derived therefrom and
the proceed from the sales thereof in real properties and securities," as a result of which said properties and
investments steadily increased yearly from P87,860.00 in "land account" and P17,590.00 in "building account" in
1949 to P175,028.68 in "investment account," P135.714.68 in "land account" and P169,262.52 in "building
account" in 1956. And all these became possible because, admittedly, petitioners never actually received any
share of the income or profits from Lorenzo T. Oña and instead, they allowed him to continue using said shares
as part of the common fund for their ventures, even as they paid the corresponding income taxes on the basis of
their respective shares of the profits of their common business as reported by the said Lorenzo T. Oña.

It is thus incontrovertible that petitioners did not, contrary to their contention, merely limit themselves to holding
the properties inherited by them. Indeed, it is admitted that during the material years herein involved, some of
the said properties were sold at considerable profit, and that with said profit, petitioners engaged, thru Lorenzo
T. Oña, in the purchase and sale of corporate securities. It is likewise admitted that all the profits from these
ventures were divided among petitioners proportionately in accordance with their respective shares in the
inheritance. In these circumstances, it is Our considered view that from the moment petitioners allowed not only
the incomes from their respective shares of the inheritance but even the inherited properties themselves to be
used by Lorenzo T. Oña as a common fund in undertaking several transactions or in business, with the intention
of deriving profit to be shared by them proportionally, such act was tantamonut to actually contributing such
incomes to a common fund and, in effect, they thereby formed an unregistered partnership within the purview of
the above-mentioned provisions of the Tax Code.

It is but logical that in cases of inheritance, there should be a period when the heirs can be considered as co-
owners rather than unregistered co-partners within the contemplation of our corporate tax laws aforementioned.
Before the partition and distribution of the estate of the deceased, all the income thereof does belong commonly
to all the heirs, obviously, without them becoming thereby unregistered co-partners, but it does not necessarily
follow that such status as co-owners continues until the inheritance is actually and physically distributed among
the heirs, for it is easily conceivable that after knowing their respective shares in the partition, they might decide
to continue holding said shares under the common management of the administrator or executor or of anyone
chosen by them and engage in business on that basis. Withal, if this were to be allowed, it would be the easiest
thing for heirs in any inheritance to circumvent and render meaningless Sections 24 and 84(b) of the National
Internal Revenue Code.

It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for holding the
appellants therein to be unregistered co-partners for tax purposes, that their common fund "was not something
they found already in existence" and that "it was not a property inherited by them pro indiviso," but it is certainly
far fetched to argue therefrom, as petitioners are doing here, that ergo, in all instances where an inheritance is
not actually divided, there can be no unregistered co-partnership. As already indicated, for tax purposes, the co-
ownership of inherited properties is automatically converted into an unregistered partnership the moment the
10
said common properties and/or the incomes derived therefrom are used as a common fund with intent to
produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a project
partition either duly executed in an extrajudicial settlement or approved by the court in the corresponding testate
or intestate proceeding. The reason for this is simple. From the moment of such partition, the heirs are entitled
already to their respective definite shares of the estate and the incomes thereof, for each of them to manage and
dispose of as exclusively his own without the intervention of the other heirs, and, accordingly he becomes liable
individually for all taxes in connection therewith. If after such partition, he allows his share to be held in common
with his co-heirs under a single management to be used with the intent of making profit thereby in proportion to
his share, there can be no doubt that, even if no document or instrument were executed for the purpose, for tax
purposes, at least, an unregistered partnership is formed. This is exactly what happened to petitioners in this
case.

In this connection, petitioners' reliance on Article 1769, paragraph (3), of the Civil Code, providing that: "The
sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have
a joint or common right or interest in any property from which the returns are derived," and, for that matter, on
any other provision of said code on partnerships is unavailing. In Evangelista, supra, this Court clearly
differentiated the concept of partnerships under the Civil Code from that of unregistered partnerships which are
considered as "corporations" under Sections 24 and 84(b) of the National Internal Revenue Code. Mr. Justice
Roberto Concepcion, now Chief Justice, elucidated on this point thus:

To begin with, the tax in question is one imposed upon "corporations", which, strictly speaking,
are distinct and different from "partnerships". When our Internal Revenue Code includes
"partnerships" among the entities subject to the tax on "corporations", said Code must allude,
therefore, to organizations which are not necessarily "partnerships", in the technical sense of the
term. Thus, for instance, section 24 of said Code exempts from the aforementioned tax "duly
registered general partnerships," which constitute precisely one of the most typical forms of
partnerships in this jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term
corporation includes partnerships, no matter how created or organized." This qualifying
expression clearly indicates that a joint venture need not be undertaken in any of the standard
forms, or in confirmity with the usual requirements of the law on partnerships, in order that one
could be deemed constituted for purposes of the tax on corporation. Again, pursuant to said
section 84(b),the term "corporation" includes, among others, "joint accounts,(cuentas en
participacion)" and "associations", none of which has a legal personality of its own, independent
of that of its members. Accordingly, the lawmaker could not have regarded that personality as a
condition essential to the existence of the partnerships therein referred to. In fact, as above
stated, "duly registered general co-partnerships" — which are possessed of the aforementioned
personality — have been expressly excluded by law (sections 24 and 84[b]) from the connotation
of the term "corporation." ....

xxx xxx xxx

Similarly, the American Law

... provides its own concept of a partnership. Under the term "partnership" it
includes not only a partnership as known in common law but, as well, a
syndicate, group, pool, joint venture, or other unincorporated organization which
carries on any business, financial operation, or venture, and which is not, within
the meaning of the Code, a trust, estate, or a corporation. ... . (7A Merten's Law
of Federal Income Taxation, p. 789; emphasis ours.)

The term "partnership" includes a syndicate, group, pool, joint venture or other
unincorporated organization, through or by means of which any business,
financial operation, or venture is carried on. ... . (8 Merten's Law of Federal
Income Taxation, p. 562 Note 63; emphasis ours.)

For purposes of the tax on corporations, our National Internal Revenue Code includes these
partnerships — with the exception only of duly registered general copartnerships — within the
purview of the term "corporation." It is, therefore, clear to our mind that petitioners herein

11
 constitute a partnership, insofar as said Code is concerned, and are subject to the income tax for
corporations.

We reiterated this view, thru Mr. Justice Fernando, in Reyes vs. Commissioner of Internal Revenue, G. R. Nos.
L-24020-21, July 29, 1968, 24 SCRA 198, wherein the Court ruled against a theory of co-ownership pursued by
appellants therein.

As regards the second question raised by petitioners about the segregation, for the purposes of the corporate
taxes in question, of their inherited properties from those acquired by them subsequently, We consider as
justified the following ratiocination of the Tax Court in denying their motion for reconsideration:

In connection with the second ground, it is alleged that, if there was an unregistered partnership,
the holding should be limited to the business engaged in apart from the properties inherited by
petitioners. In other words, the taxable income of the partnership should be limited to the income
derived from the acquisition and sale of real properties and corporate securities and should not
include the income derived from the inherited properties. It is admitted that the inherited
properties and the income derived therefrom were used in the business of buying and selling
other real properties and corporate securities. Accordingly, the partnership income must include
not only the income derived from the purchase and sale of other properties but also the income
of the inherited properties.

Besides, as already observed earlier, the income derived from inherited properties may be considered as
individual income of the respective heirs only so long as the inheritance or estate is not distributed or, at least,
partitioned, but the moment their respective known shares are used as part of the common assets of the heirs to
be used in making profits, it is but proper that the income of such shares should be considered as the part of the
taxable income of an unregistered partnership. This, We hold, is the clear intent of the law.

Likewise, the third question of petitioners appears to have been adequately resolved by the Tax Court in the
aforementioned resolution denying petitioners' motion for reconsideration of the decision of said court.
Pertinently, the court ruled this wise:

In support of the third ground, counsel for petitioners alleges:

Even if we were to yield to the decision of this Honorable Court that the herein
petitioners have formed an unregistered partnership and, therefore, have to be
taxed as such, it might be recalled that the petitioners in their individual income
tax returns reported their shares of the profits of the unregistered partnership. We
think it only fair and equitable that the various amounts paid by the individual
petitioners as income tax on their respective shares of the unregistered
partnership should be deducted from the deficiency income tax found by this
Honorable Court against the unregistered partnership. (page 7, Memorandum for
the Petitioner in Support of Their Motion for Reconsideration, Oct. 28, 1961.)

In other words, it is the position of petitioners that the taxable income of the partnership must be
reduced by the amounts of income tax paid by each petitioner on his share of partnership profits.
This is not correct; rather, it should be the other way around. The partnership profits distributable
to the partners (petitioners herein) should be reduced by the amounts of income tax assessed
against the partnership. Consequently, each of the petitioners in his individual capacity overpaid
his income tax for the years in question, but the income tax due from the partnership has been
correctly assessed. Since the individual income tax liabilities of petitioners are not in issue in this
proceeding, it is not proper for the Court to pass upon the same.

Petitioners insist that it was error for the Tax Court to so rule that whatever excess they might have paid as
individual income tax cannot be credited as part payment of the taxes herein in question. It is argued that to
sanction the view of the Tax Court is to oblige petitioners to pay double income tax on the same income, and,
worse, considering the time that has lapsed since they paid their individual income taxes, they may already be
barred by prescription from recovering their overpayments in a separate action. We do not agree. As We see it,
the case of petitioners as regards the point under discussion is simply that of a taxpayer who has paid the wrong

12
tax, assuming that the failure to pay the corporate taxes in question was not deliberate. Of course, such taxpayer
has the right to be reimbursed what he has erroneously paid, but the law is very clear that the claim and action
for such reimbursement are subject to the bar of prescription. And since the period for the recovery of the excess
income taxes in the case of herein petitioners has already lapsed, it would not seem right to virtually disregard
prescription merely upon the ground that the reason for the delay is precisely because the taxpayers failed to
make the proper return and payment of the corporate taxes legally due from them. In principle, it is but proper
not to allow any relaxation of the tax laws in favor of persons who are not exactly above suspicion in their
conduct vis-a-vis their tax obligation to the State.

IN VIEW OF ALL THE FOREGOING, the judgment of the Court of Tax Appeals appealed from is affirm with
costs against petitioners.

Makalintal, Zaldivar, Fernando, Makasiar and Antonio, JJ., concur.

Reyes, J.B.L. and Teehankee, JJ., concur in the result.

Castro, J., took no part.

Concepcion, C.J., is on leave.

Footnotes

1 In other words, the assessment was affirmed except for the sum of P100.00 which was the
total of two P50-items purportedly for "Compromise for non-filing" which the Tax Court held to be
unjustified, since there was no compromise agreement to speak of.

G.R. No. L-68118 October 29, 1985

JOSE P. OBILLOS, JR., SARAH P. OBILLOS, ROMEO P. OBILLOS and REMEDIOS P. OBILLOS, brothers
and sisters, petitioners
vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

Demosthenes B. Gadioma for petitioners.

AQUINO, J.:

This case is about the income tax liability of four brothers and sisters who sold two parcels of land which they
had acquired from their father.

On March 2, 1973 Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. on two lots with areas of 1,124
and 963 square meters located at Greenhills, San Juan, Rizal. The next day he transferred his rights to his four
children, the petitioners, to enable them to build their residences. The company sold the two lots to petitioners
for P178,708.12 on March 13 (Exh. A and B, p. 44, Rollo). Presumably, the Torrens titles issued to them would
show that they were co-owners of the two lots.

13
In 1974, or after having held the two lots for more than a year, the petitioners resold them to the Walled City
Securities Corporation and Olga Cruz Canda for the total sum of P313,050 (Exh. C and D). They derived from
the sale a total profit of P134,341.88 or P33,584 for each of them. They treated the profit as a capital gain and
paid an income tax on one-half thereof or of P16,792.

In April, 1980, or one day before the expiration of the five-year prescriptive period, the Commissioner of Internal
Revenue required the four petitioners to pay corporate income tax on the total profit of P134,336 in addition to
individual income tax on their shares thereof He assessed P37,018 as corporate income tax, P18,509 as 50%
fraud surcharge and P15,547.56 as 42% accumulated interest, or a total of P71,074.56.

Not only that. He considered the share of the profits of each petitioner in the sum of P33,584 as a " taxable in full
(not a mere capital gain of which ½ is taxable) and required them to pay deficiency income taxes aggregating
P56,707.20 including the 50% fraud surcharge and the accumulated interest.

Thus, the petitioners are being held liable for deficiency income taxes and penalties totalling P127,781.76 on
their profit of P134,336, in addition to the tax on capital gains already paid by them.

The Commissioner acted on the theory that the four petitioners had formed an unregistered partnership or joint
venture within the meaning of sections 24(a) and 84(b) of the Tax Code (Collector of Internal Revenue vs.
Batangas Trans. Co., 102 Phil. 822).

The petitioners contested the assessments. Two Judges of the Tax Court sustained the same. Judge Roaquin
dissented. Hence, the instant appeal.

We hold that it is error to consider the petitioners as having formed a partnership under article 1767 of the Civil
Code simply because they allegedly contributed P178,708.12 to buy the two lots, resold the same and divided
the profit among themselves.

To regard the petitioners as having formed a taxable unregistered partnership would result in oppressive
taxation and confirm the dictum that the power to tax involves the power to destroy. That eventuality should be
obviated.

As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure and simple. To consider
them as partners would obliterate the distinction between a co-ownership and a partnership. The petitioners
were not engaged in any joint venture by reason of that isolated transaction.

Their original purpose was to divide the lots for residential purposes. If later on they found it not feasible to build
their residences on the lots because of the high cost of construction, then they had no choice but to resell the
same to dissolve the co-ownership. The division of the profit was merely incidental to the dissolution of the co-
ownership which was in the nature of things a temporary state. It had to be terminated sooner or later. Castan
Tobeñas says:

Como establecer el deslinde entre la comunidad ordinaria o copropiedad y la sociedad?

El criterio diferencial-segun la doctrina mas generalizada-esta: por razon del origen, en que la
sociedad presupone necesariamente la convencion, mentras que la comunidad puede existir y
existe ordinariamente sin ela; y por razon del fin objecto, en que el objeto de la sociedad es
obtener lucro, mientras que el de la indivision es solo mantener en su integridad la cosa comun y
favorecer su conservacion.

Reflejo de este criterio es la sentencia de 15 de Octubre de 1940, en la que se dice que si en

nuestro Derecho positive se ofrecen a veces dificultades al tratar de fijar la linea divisoria entre
comunidad de bienes y contrato de sociedad, la moderna orientacion de la doctrina cientifica
señala como nota fundamental de diferenciacion aparte del origen de fuente de que surgen, no
siempre uniforme, la finalidad perseguida por los interesados: lucro comun partible en la
sociedad, y mera conservacion y aprovechamiento en la comunidad. (Derecho Civil Espanol,
Vol. 2, Part 1, 10 Ed., 1971, 328- 329).

14
Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of itself establish a
partnership, whether or not the persons sharing them have a joint or common right or interest in any property
from which the returns are derived". There must be an unmistakable intention to form a partnership or joint
venture.*

Such intent was present in Gatchalian vs. Collector of Internal Revenue, 67 Phil. 666, where 15 persons contributed small amounts to purchase a two-peso
sweepstakes ticket with the agreement that they would divide the prize The ticket won the third prize of P50,000. The 15 persons were held liable for income
tax as an unregistered partnership.

The instant case is distinguishable from the cases where the parties engaged in joint ventures for profit. Thus, in
Oña vs.

** This view is supported by the following rulings of respondent Commissioner:

Co-owership distinguished from partnership.—We find that the case at bar is fundamentally
similar to the De Leon case. Thus, like the De Leon heirs, the Longa heirs inherited the
'hacienda' in question pro-indiviso from their deceased parents; they did not contribute or invest
additional ' capital to increase or expand the inherited properties; they merely continued
dedicating the property to the use to which it had been put by their forebears; they individually
reported in their tax returns their corresponding shares in the income and expenses of the
'hacienda', and they continued for many years the status of co-ownership in order, as conceded
by respondent, 'to preserve its (the 'hacienda') value and to continue the existing contractual
relations with the Central Azucarera de Bais for milling purposes. Longa vs. Aranas, CTA Case
No. 653, July 31, 1963).

All co-ownerships are not deemed unregistered pratnership.—Co-Ownership who own properties
which produce income should not automatically be considered partners of an unregistered
partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would
be to subject the income of all
co-ownerships of inherited properties to the tax on corporations, inasmuch as if a property does
not produce an income at all, it is not subject to any kind of income tax, whether the income tax
on individuals or the income tax on corporation. (De Leon vs. CI R, CTA Case No. 738,
September 11, 1961, cited in Arañas, 1977 Tax Code Annotated, Vol. 1, 1979 Ed., pp. 77-78).

Commissioner of Internal Revenue, L-19342, May 25, 1972, 45 SCRA 74, where after an extrajudicial settlement
the co-heirs used the inheritance or the incomes derived therefrom as a common fund to produce profits for
themselves, it was held that they were taxable as an unregistered partnership.

It is likewise different from Reyes vs. Commissioner of Internal Revenue, 24 SCRA 198, where father and son
purchased a lot and building, entrusted the administration of the building to an administrator and divided equally
the net income, and from Evangelista vs. Collector of Internal Revenue, 102 Phil. 140, where the three
Evangelista sisters bought four pieces of real property which they leased to various tenants and derived rentals
therefrom. Clearly, the petitioners in these two cases had formed an unregistered partnership.

In the instant case, what the Commissioner should have investigated was whether the father donated the two
lots to the petitioners and whether he paid the donor's tax (See Art. 1448, Civil Code). We are not prejudging this
matter. It might have already prescribed.

WHEREFORE, the judgment of the Tax Court is reversed and set aside. The assessments are cancelled. No
costs.

SO ORDERED.

G.R. No. L-21551 September 30, 1969

15
FERNANDEZ HERMANOS, INC., petitioner,
vs.
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

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

G.R. No. L-21557 September 30, 1969

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
FERNANDEZ HERMANOS, INC., and COURT OF TAX APPEALS, respondents.

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

G.R. No. L-24972 September 30, 1969

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
FERNANDEZ HERMANOS INC., and the COURT OF TAX APPEALS, respondents.

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

G.R. No. L-24978 September 30, 1969

FERNANDEZ HERMANOS, INC., petitioner,

vs.
THE COMMISSIONER OF INTERNAL REVENUE, and HON. ROMAN A. UMALI, COURT OF TAX
APPEALS,respondents.

L-21551:

Rafael Dinglasan for petitioner.

Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong and Special Attorney Virgilio G.
Saldajeno for respondent.

L-21557:

Office of the Solicitor General for petitioner.

Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

L-24972:

Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special
Attorney Virgilio G. Saldajeno for petitioner.
Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

L-24978:

Rafael Dinglasan for petitioner.

Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Antonio G. Ibarra and Special
Attorney Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.:

16
These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax
liability for the years 1950 to 1954 and for the year 1957. Both the taxpayer and the Commissioner of Internal
Revenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax Court's
decisions, insofar as their respective contentions on particular tax items were therein resolved against them.
Since the issues raised are interrelated, the Court resolves the four appeals in this joint decision.

Cases L-21551 and L-21557

The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of
engaging in business as an "investment company" with main office at Manila. Upon verification of the taxpayer's
income tax returns for the period in question, the Commissioner of Internal Revenue assessed against the
taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and P14,451.00 as alleged deficiency
income taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said assessments were the result of
alleged discrepancies found upon the examination and verification of the taxpayer's income tax returns for the
said years, summarized by the Tax Court in its decision of June 10, 1963 in CTA Case No. 787, as follows:

1. Losses —

a. Losses in Mati Lumber Co. (1950) P 8,050.00

b. Losses in or bad debts of Palawan Manganese Mines, Inc. (1951) 353,134.25

c. Losses in Balamban Coal Mines —

1950 8,989.76
1951 27,732.66

d. Losses in Hacienda Dalupiri —

1950 17,418.95
1951 29,125.82
1952 26,744.81
1953 21,932.62
1954 42,938.56

e. Losses in Hacienda Samal —

1951 8,380.25
1952 7,621.73

2. Excessive depreciation of Houses —

1950 P 8,180.40
1951 8,768.11
1952 18,002.16
1953 13,655.25
1954 29,314.98

3. Taxable increase in net worth —

1950 P 30,050.00
1951 1,382.85

17
 4. Gain realized from sale of real property in 1950 P 11,147.2611

The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item 2
of the above summary, but overruled the Commissioner's disallowances of all the remaining items. It
therefore modified the deficiency assessments accordingly, found the total deficiency income taxes due
from the taxpayer for the years under review to amount to P123,436.00 instead of P166,063.00 as
originally assessed by the Commissioner, and rendered the following judgment:

RESUME

1950 P2,748.00
1951 108,724.00
1952 3,600.00
1953 2,501.00
1954 5,863.00

Total P123,436.00

WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the sum
of P123,436.00 within 30 days from the date this decision becomes final. If the said amount, or any part
thereof, is not paid within said period, there shall be added to the unpaid amount as surcharge of 5%,
plus interest as provided in Section 51 of the National Internal Revenue Code, as amended. With costs
against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)

Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two
main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to the disputed
items of disallowances enumerated in the Tax Court's summary reproduced above, and second, whether or not
the government's right to collect the deficiency income taxes in question has already prescribed.

On the first issue, we will discuss the disputed items of disallowances seriatim.

1. Re allowances/disallowances of losses.

(a) Allowance of losses in Mati Lumber Co. (1950). — The Commissioner of Internal Revenue questions the Tax
Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of P8,050.00
representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1, 1948, on the
ground that the worthlessness of said stock in the year 1950 had not been clearly established. The
Commissioner contends that although the said Company was no longer in operation in 1950, it still had its
sawmill and equipment which must be of considerable value. The Court, however, found that "the company
ceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where he
subsequently died. When the company eased to operate, it had no assets, in other words, completely insolvent.
This information as to the insolvency of the Company — reached (the taxpayer) in 1950," when it properly
claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of
the National Internal Revenue Code. 2

We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the
stock as worthless securities. Assuming that the Company would later somehow realize some proceeds from its
sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds would
later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer would then
properly be reportable as income of the taxpayer in the year it is received.

(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). — The taxpayer appeals
from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25, which
it had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings on this item follow:

18
 Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also the
controlling stockholders of petitioner corporation, requested financial help from petitioner to enable it to
resume it mining operations in Coron, Palawan. The request for financial assistance was readily and
unanimously approved by the Board of Directors of petitioner, and thereafter a memorandum agreement
was executed on August 12, 1945, embodying the terms and conditions under which the financial
assistance was to be extended, the pertinent provisions of which are as follows:

"WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has
agreed to extend to the SECOND PARTY the requested financial help by way of accommodation
advances and for this purpose has authorized its President, Mr. Ramon J. Fernandez to cause
the release of funds to the SECOND PARTY.

"WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to extend to
the SECOND PARTY, the latter has agreed to pay to the former fifteen per centum (15%) of its
net profits.

"NOW THEREFORE, for and in consideration of the above premises, the parties hereto have
agreed and covenanted that in consideration of the financial help to be extended by the FIRST
PARTY to the SECOND PARTY to enable the latter to resume its mining operations in Coron,
Palawan, the SECOND PARTY has agreed and undertaken as it hereby agrees and undertakes
to pay to the FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)

Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly
advances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these
advances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By
1951, petitioner became convinced that those advances could no longer be recovered. While it continued to give
advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the basis
of the total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum of
P85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136-139, Id)." (Page
4, Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950 and 1951 in the hope
that it might be able to recover the same, as in fact it continued to give advances up to 1952. From these facts,
and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advances
corresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, was
the sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as
losses or bad debts?

It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be repaid. It
is true that some testimonial evidence was presented to show that there was some agreement that the advances
would be repaid, but no documentary evidence was presented to this effect. The memorandum agreement
signed by the parties appears to be very clear that the consideration for the advances made by petitioner was
15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits,
there was no obligation to repay those advances. It has been held that the voluntary advances made without
expectation of repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329, citing W. F.
Young, Inc. v. Comm., 120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC. 1593.

Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan
Manganese Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under the
memorandum agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner 15%
of its net profits, not the advances. No bad debt could arise where there is no valid and subsisting debt.

Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of
paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said
year, yet the debt is not deductible in 1951 as a worthless debt. It appears that the debtor was still in operation in
1951 and 1952, as petitioner continued to give advances in those years. It has been held that if the debtor
corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is not
considered worthless and therefore not deductible. 3

19
The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the
taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount
involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt." 4 We sustain the
government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese
Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record
shows that the board of directors of the two companies since August, 1945, were identical and that the only
capital of Palawan Manganese Mines, Inc. is the amount of P100,000.00 entered in the taxpayer's balance sheet
as its investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer made such
large advances to the subsidiary, despite the latter's admittedly poor financial condition.

The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that
under their memorandum agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no
earnings, there was no obligation to repay those advances, becomes immaterial, in the light of our resolution of
the question. The Tax Court correctly held that the subsidiary company was still in operation in 1951 and 1952
and the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or investment
could not properly be considered worthless and deductible in 1951, as claimed by the taxpayer. Furthermore,
neither under Section 30 (d) (2) of our Tax Code providing for deduction by corporations of losses actually
sustained and charged off during the taxable year nor under Section 30 (e) (1) thereof providing for deduction of
bad debts actually ascertained to be worthless and charged off within the taxable year, can there be a partial
writing off of a loss or bad debt, as was sought to be done here by the taxpayer. For such losses or bad debts
must be ascertained to be so and written off during the taxable year, are therefore deductible in full or not at all,
in the absence of any express provision in the Tax Code authorizing partial deductions.

The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the year
1951, as the subsidiary was still in operation in 1951 and 1952. The taxpayer, on the other hand, claims that its
advances were irretrievably lost because of the staggering losses suffered by its subsidiary in 1951 and that its
advances after 1949 were "only limited to the purpose of salvaging whatever ore was already available, and for
the purpose of paying the wages of the laborers who needed help." 7 The correctness of the Tax Court's ruling in
sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is borne out by subsequent
events shown in Cases L-24972 and L-24978 involving the taxpayer's 1957 income tax liability. (Infra, paragraph
6.) It will there be seen that by 1956, the obligation of the taxpayer's subsidiary to it had been reduced from
P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January 1, 1956 that the subsidiary
decided to cease operations. 8

(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The Court sustains the Tax Court's
disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its Balamban
coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns for said
years. The Tax Court correctly held that the losses "are deductible in 1952, when the mines were abandoned,
and not in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these expeditions
should be allowed as losses for the corresponding years that they were incurred, because it made no sales of
coal during said years, since the promised road or outlet through which the coal could be transported from the
mines to the provincial road was not constructed, cannot be sustained. Some definite event must fix the time
when the loss is sustained, and here it was the event of actual abandonment of the mines in 1952. The Tax
Court held that the losses, totalling P36,722.42 were properly deductible in 1952, but the appealed judgment
does not show that the taxpayer was credited therefor in the determination of its tax liability for said year. This
additional deduction of P36,722.42 from the taxpayer's taxable income in 1952 would result in the elimination of
the deficiency tax liability for said year in the sum of P3,600.00 as determined by the Tax Court in the appealed
judgment.

(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). — The
Tax Court overruled the Commissioner's disallowance of these items of losses thus:

Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950,
P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These
deductions were disallowed by respondent on the ground that the farm was operated solely for pleasure
or as a hobby and not for profit. This conclusion is based on the fact that the farm was operated
continuously at a loss.1awphîl.nèt

20
 From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for business
and not pleasure. It was mainly a cattle farm, although a few race horses were also raised. It does not
appear that the farm was used by petitioner for entertainment, social activities, or other non-business
purposes. Therefore, it is entitled to deduct expenses and losses in connection with the operation of said
farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1, p.164)

Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations, authorizes
farmers to determine their gross income on the basis of inventories. Said regulations provide:

"If gross income is ascertained by inventories, no deduction can be made for livestock or
products lost during the year, whether purchased for resale, produced on the farm, as such
losses will be reflected in the inventory by reducing the amount of livestock or products on hand
at the close of the year."

Evidently, petitioner determined its income or losses in the operation of said farm on the basis of
inventories. We quote from the memorandum of counsel for petitioner:

"The Taxpayer deducted from its income tax returns for the years from 1950 to 1954 inclusive,
the corresponding yearly losses sustained in the operation of Hacienda Dalupiri, which losses
represent the excess of its yearly expenditures over the receipts; that is, the losses represent the
difference between the sales of livestock and the actual cash disbursements or expenses."
(Pages 21-22, Memorandum for Petitioner.)

As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its
operation, which losses were determined by means of inventories authorized under Section 100 of
Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said losses.
The same is true with respect to loss sustained in the operation of the Hacienda Samal for the years
1951 and 1952. 10

The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory
method of accounting. He concedes, however, "that the regulations referred to does not specify how the
inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the taxpayer
... which merely consisted of an alleged physical count of the number of the livestock in Hacienda Dalupiri for the
years involved." 11The Tax Court was satisfied with the method adopted by the taxpayer as a farmer breeding
livestock, reporting on the basis of receipts and disbursements. We find no Compelling reason to disturb its
findings.

2. Disallowance of excessive depreciation of buildings (1950-1954). — During the years 1950 to 1954, the
taxpayer claimed a depreciation allowance for its buildings at the annual rate of 10%. The Commissioner
claimed that the reasonable depreciation rate is only 3% per annum, and, hence, disallowed as excessive the
amount claimed as depreciation allowance in excess of 3% annually. We sustain the Tax Court's finding that the
taxpayer did not submit adequate proof of the correctness of the taxpayer's claim that the depreciable assets or
buildings in question had a useful life only of 10 years so as to justify its 10% depreciation per annum claim,
such finding being supported by the record. The taxpayer's contention that it has many zero or one-peso
assets, 12 representing very old and fully depreciated assets serves but to support the Commissioner's position
that a 10% annual depreciation rate was excessive.

3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the Commissioner's treatment as
taxable income of certain increases in the taxpayer's net worth. It found that:

For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of
P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated by respondent
as taxable income of petitioner for said years.

It appears that petitioner had an account with the Manila Insurance Company, the records bearing on
which were lost. When its records were reconstituted the amount of P349,800.00 was set up as its
liability to the Manila Insurance Company. It was discovered later that the correct liability was only
319,750.00, or a difference of P30,050.00, so that the records were adjusted so as to show the correct
21
 liability. The correction or adjustment was made in 1950. Respondent contends that the reduction of
petitioner's liability to Manila Insurance Company resulted in the increase of petitioner's net worth to the
extent of P30,050.00 which is taxable. This is erroneous. The principle underlying the taxability of an
increase in the net worth of a taxpayer rests on the theory that such an increase in net worth, if
unreported and not explained by the taxpayer, comes from income derived from a taxable source. (See
Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 & L-11558, Nov.
25, 1958.) In this case, the increase in the net worth of petitioner for 1950 to the extent of P30,050.00
was not the result of the receipt by it of taxable income. It was merely the outcome of the correction of an
error in the entry in its books relating to its indebtedness to the Manila Insurance Company. The Income
Tax Law imposes a tax on income; it does not tax any or every increase in net worth whether or not
derived from income. Surely, the said sum of P30,050.00 was not income to petitioner, and it was error
for respondent to assess a deficiency income tax on said amount.

The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum of
P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in petitioner's books as
outstanding liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior
years, so that the necessary adjustments were made to correct the errors. If there was an increase in net worth
of the petitioner, the increase in net worth was not the result of receipt by petitioner of taxable income." 13 The
Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings. Certainly, these
increases in the taxpayer's net worth were not taxable increases in net worth, as they were not the result of the
receipt by it of unreported or unexplained taxable income, but were shown to be merely the result of the
correction of errors in its entries in its books relating to its indebtednesses to certain creditors, which had been
erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax Court's action
must be affirmed.

4. Gain realized from sale of real property (1950). — We likewise sustain as being in accordance with the
evidence the Tax Court's reversal of the Commissioner's assessment on all alleged unreported gain in the sum
of P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As found by the Tax Court, the
evidence shows that this property was acquired in 1926 for P11,852.74, and was sold in 1950 for P60,000.00,
apparently, resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of P37,000.00, or a
discrepancy of P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after acquiring the
property, the taxpayer had made improvements totalling P11,147.26, 16 accounting for the apparent discrepancy
in the reported gain. In other words, this figure added to the original acquisition cost of P11,852.74 results in a
total cost of P23,000.00, and the gain derived from the sale of the property for P60,000.00 was correctly
reported by the taxpayer at P37,000.00.

On the second issue of prescription, the taxpayer's contention that the Commissioner's action to recover its tax
liability should be deemed to have prescribed for failure on the part of the Commissioner to file a complaint for
collection against it in an appropriate civil action, as contradistinguished from the answer filed by the
Commissioner to its petition for review of the questioned assessments in the case a quo has long been rejected
by this Court. This Court has consistently held that "a judicial action for the collection of a tax is begun by the
filing of a complaint with the proper court of first instance, or where the assessment is appealed to the Court of
Tax Appeals, by filing an answer to the taxpayer's petition for review wherein payment of the tax is prayed
for." 17 This is but logical for where the taxpayer avails of the right to appeal the tax assessment to the Court of
Tax Appeals, the said Court is vested with the authority to pronounce judgment as to the taxpayer's liability to
the exclusion of any other court. In the present case, regardless of whether the assessments were made on
February 24 and 27, 1956, as claimed by the Commissioner, or on December 27, 1955 as claimed by the
taxpayer, the government's right to collect the taxes due has clearly not prescribed, as the taxpayer's appeal or
petition for review was filed with the Tax Court on May 4, 1960, with the Commissioner filing on May 20, 1960
his Answer with a prayer for payment of the taxes due, long before the expiration of the five-year period to effect
collection by judicial action counted from the date of assessment.

Cases L-24972 and L-24978

These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its corresponding
income tax return, the Commissioner assessed it for deficiency income tax in the amount of P38,918.76,
computed as follows:

22
 Net income per return P29,178.70

Add: Unallowable deductions:

(1) Net loss claimed on Ha. Dalupiri 89,547.33
(2) Amortization of Contractual right claimed as
an expense under Mines Operations 48,481.62

Net income per investigation P167,297.65

Tax due thereon 38,818.00

Less: Amount already assessed 5,836.00

Balance P32,982.00
Add: 1/2% monthly interest from 6-20-59 to
6-20-62 5,936.76

TOTAL AMOUNT DUE AND COLLECTIBLE P38,918.76 18

The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its
Hacienda Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62, which
allegedly represented 1/5 of the cost of the "contractual right" over the mines of its subsidiary, Palawan
Manganese Mines, Inc. which the taxpayer had acquired. It found the taxpayer liable for deficiency income tax
for the year 1957 in the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the
following judgment:

WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to pay to
respondent the amount of P9,696.00 as deficiency income tax for the year 1957, plus the corresponding
interest provided in Section 51 of the Revenue Code. If the deficiency tax is not paid in full within thirty
(30) days from the date this decision becomes final and executory, petitioner shall pay a surcharge of
five per cent (5%) of the unpaid amount, plus interest at the rate of one per cent (1%) a month,
computed from the date this decision becomes final until paid, provided that the maximum amount that
may be collected as interest shall not exceed the amount corresponding to a period of three (3) years.
Without pronouncement as to costs. 19

Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.

5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited its previous decision overruling the
Commissioner's disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri, since it
was convinced that the hacienda was operated for business and not for pleasure. And in this appeal, the
Commissioner cites his arguments in his appellant's brief in Case No. L-21557. The Tax Court, in setting aside
the Commissioner's principal objections, which were directed to the accounting method used by the taxpayer
found that:

It is true that petitioner followed the cash basis method of reporting income and expenses in the
operation of the Hacienda Dalupiri and used the accrual method with respect to its mine operations. This
method of accounting, otherwise known as the hybrid method, followed by petitioner is not without
justification.

... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code
provisions permit, however, the use of a hybrid method of accounting, combining a cash and
accrual method, under circumstances and requirements to be set out in Regulations to be
issued. Also, if a taxpayer is engaged in more than one trade or business he may use a different
method of accounting for each trade or business. And a taxpayer may report income from a
business on accrual basis and his personal income on the cash basis.' (See Mertens, Law of
Federal Income Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p. 26.) 20

23
 The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and
procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having failed to
show the contrary, we reiterate our ruling [supra, paragraph 1 (d) and (e)] that we find no compelling
reason to disturb its findings.

6. Disallowance of amortization of alleged "contractual rights." — The reasons for sustaining this disallowance
are thus given by the Tax Court:

It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of Directors on
January 19, 1956, approved a resolution, the pertinent portions of which read as follows:

"RESOLVED, as it is hereby resolved, that the corporation's current assets composed of ores,
fuel, and oil, materials and supplies, spare parts and canteen supplies appearing in the inventory
and balance sheet of the Corporation as of December 31, 1955, with an aggregate value of
P97,636.98, contractual rights for the operation of various mining claims in Palawan with a value
of P100,000.00, its title on various mining claims in Palawan with a value of P142,408.10 or a
total value of P340,045.02 be, as they are hereby ceded and transferred to Fernandez
Hermanos, Inc., as partial settlement of the indebtedness of the corporation to said Fernandez
Hermanos Inc. in the amount of P442,895.23." (Exh. E, p. 17, CTA rec.)

On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus:

"WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has
decided to cease operation on January 1, 1956 and in order to satisfy at least a part of its
indebtedness to the Corporation, it has proposed to transfer its current assets in the amount of
NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100 (P97,636.98) as
per its balance sheet as of December 31, 1955, its contractual rights valued at ONE HUNDRED
THOUSAND PESOS (P100,000.00) and its title over various mining claims valued at ONE
HUNDRED FORTY TWO THOUSAND FOUR HUNDRED EIGHT PESOS & 10/100
(P142,408.10) or a total evaluation of THREE HUNDRED FORTY THOUSAND FORTY FIVE
PESOS & 08/100 (P340,045.08) which shall be applied in partial settlement of its obligation to
the Corporation in the amount of FOUR HUNDRED FORTY TWO THOUSAND EIGHT
HUNDRED EIGHTY FIVE PESOS & 23/100 (P442,885.23)," (Exh. E-1, p. 18, CTA rec.)

Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual rights
(P100,000.00) and the value of its mining claims (P142,408.10). Respondent disallowed the deduction
on the following grounds: (1) that the Palawan Manganese Mines, Inc. could not transfer P242,408.10
worth of assets to petitioner because the balance sheet of the said corporation for 1955 shows that it had
only current as worth P97,636.96; and (2) that the alleged amortization of "contractual rights" is not
allowed by the Revenue Code.

The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act No.
2698, which provided in part:

"(g) Depletion of oil and gas wells and mines.:

"(1) In general. — ... (B) in the case of mines, a reasonable allowance for depletion thereof not to
exceed the market value in the mine of the product thereof, which has been mined and sold
during the year for which the return and computation are made. The allowances shall be made
under rules and regulations to be prescribed by the Secretary of Finance: Provided, That when
the allowances shall equal the capital invested, ... no further allowance shall be made."

Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which it
actually transferred to the petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said amount
from its gross income for the year 1957 because such deduction in the form of depletion charge was not
sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.

xxx xxx xxx

24
 The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the memorandum
of its mining engineer (Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves of the Busuange
Mines (Mines transferred by the Palawan Manganese Mines, Inc. to the petitioner) would be exhausted
in five (5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of the alleged cost of the mines
corresponding to the year 1957 and every year thereafter for a period of 5 years. The said memorandum
merely showed the estimated ore reserves of the mines and it probable selling price. No evidence
whatsoever was presented to show the produced mine and for how much they were sold during the year
for which the return and computation were made. This is necessary in order to determine the amount of
depletion that can be legally deducted from petitioner's gross income. The method employed by
petitioner in making an outright deduction of 1/5 of the cost of the mines is not authorized under Section
30(g) (1) (B) of the Revenue Code. Respondent's disallowance of the alleged "contractual rights"
amounting to P48,481.62 must therefore be sustained. 21

The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of the
Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to mining
claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of this "capital investment" every year.
regardless of whether it had actually mined the product and sold the products. The very authorities cited in its
brief give the correct concept of depletion charges that they "allow for the exhaustion of the capital value of the
deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross income before
the net income can be determined, so the estimated cost of the reserve used up is allowed." 22 The alleged
"capital investment" method invoked by the taxpayer is not a method of depletion, but the Tax Code provision,
prior to its amendment by Section 1, of Republic Act No. 2698, which took effect on June 18, 1960, expressly
provided that "when the allowances shall equal the capital invested ... no further allowances shall be made;" in
other words, the "capital investment" was but the limitation of the amount of depletion that could be claimed. The
outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it were a "straight line" rate of
depreciation, was correctly held by the Tax Court not to be authorized by the Tax Code.

ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551 and
L-21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the taxpayer
for the year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The judgment of the Court of
Tax Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in toto. No costs. So ordered.

G.R. Nos. L-66059-60 December 4, 1989

FILIPINAS INVESTMENT and FINANCE CORPORATION, petitioner,

vs.
INTERMEDIATE APPELLATE COURT and FELIMON CUEVAS, respondents.

Labaguis, Loyola, Angara & Associates for petitioner.

Benjamin G. Calima for private respondent.

MEDIALDEA, J.:

This is a petition for review on certiorari of the decision of the Intermediate Appellate Court (now Court of
Appeals) dated October 28, 1983 and its resolution dated December 29, 1983 in AC-G.R. CV No. 58626-27
entitled, "Filipinas Investment and Finance Corporation v. Felimon Cuevas."

The antecedent facts in the instant case are as follows:

On November 21, 1963, respondent Felimon Cuevas purchased from Ace Consolidated Inc. one unit Nissan
truck and executed a promissory note in favor of the corporation for the balance of the installment price in the
amount of P38,135.26. To secure the payment of said promissory note, respondent Cuevas executed a chattel
mortgage on the said Nissan truck. On November 22, 1963, respondent Cuevas purchased from the Ace
Consolidated, Inc. one unit Datsun Bluebird car and executed a promissory note for P12,540.00, which is the
balance of the purchase price. As security for the payment of said amount, a chattel mortgage was executed by
25
respondent Cuevas on the Datsun Bluebird car. On December 9, 1963, Cuevas again purchased from Ace
Consolidated, Inc. one unit Datsun Bluebird car, and executed a promissory note for P12,540.00, which is the
balance of the purchase price. To secure the payment thereof, Cuevas executed a chattel mortgage on the said
Datsun Bluebird car. Each of these promissory notes contains a stipulation that upon failure of the debtor to pay
any of the monthly installments, the whole sum remaining unpaid will immediately become due and payable at
the option of the holder of the note (pp. 8-18, Records). This stipulation is likewise provided in the contracts of
chattel mortgage with the condition that the mortgages may be foreclosed by the mortgagee upon failure to pay
any of the installments.

All of these promissory notes and chattel mortgages were subsequently assigned by Ace Consolidated,
Incorporated to Filipinas Investment and Finance Corporation, petitioner herein.

On July 1, 1965, Cuevas filed a complaint with preliminary injunction with the then Court of First Instance of
Manila docketed as Civil Case No. 61514 to enjoin the petitioner corporation from foreclosing the chattel
mortgage on the two Datsun cars purchased on installment by the respondent from Ace Consolidated, Inc.,
petitioner's predecessor-in-interest, and to declare the assignment made by Ace Consolidated, Inc., to Filipinas
Investment and Finance Corporation null and void. The petitioner corporation filed a counterclaim seeking the
possession of the two Datsun cars for the purpose of extrajudicial foreclosure of the chattel mortgage or, in the
alternative, the payment of the unpaid installments and the remaining balance on the promissory notes.

Meanwhile, petitioner corporation filed a complaint with the same court docketed as Civil Case No. 61651
seeking to recover from Cuevas the sum of unpaid installments on one Nissan truck purchased by the latter from
Ace Consolidated on installment basis.

Civil Cases Nos. 61514 and 61651 were consolidated and jointly tried in the trial court. Petitioner corporation
applied for the seizure of the two Datsun Bluebird cars from respondent Cuevas. The court granted the
application and the two cars were seized by the sheriff from private respondent. Thereafter, Cuevas filed a
motion for the return of the said vehicles, and for this purpose, he gave a counterbond in the amount of P20,000.
The court approved the bond and the vehicles were returned to respondent Cuevas on October 5, 1965. After
the trial, the Court rendered a judgment on October 21, 1966, which was modified in an order dated December
29, 1966. The dispositive portion of the amended decision is quoted as follows:

IN VIEW OF THE FOREGOING, in Civil Case No. 61514, judgment is rendered confirming the
possession of the Filipinas Investment and Finance Corporation to the Datsun Bluebird car which
had been seized by virtue of the writ of replevin issued by this Court and declaring the Filipinas
Investment and Finance Corporation entitled to the possession of the other Datsun Bluebird car
in order that Filipinas Investment and Finance Corporation may be able to proceed with the
extrajudicial foreclosure of the mortgages on the two Datsun Bluebird cars. Judgment is hereby
rendered in favor of Filipinas Investment and Finance Corporation and against Felimon Cuevas
and Citadel Insurance & Surety Co., Inc., jointly and severally for the return of the above-
described Datsun Bluebird car. In the event that the same cannot be delivered, judgment is
hereby rendered against them jointly and severally, and in favor of Filipinas Investment and
Finance Corporation for P7,577.1 0 with interest at the rate of 12% per annum from December 1,
1965 until paid. In the event that Filipinas Investment and Finance Corporation cannot obtain
possession of the other Datsun Bluebird car, judgment is rendered in favor of Filipinas
Investment and Finance Corporation and against Felimon Cuevas for P7,729.44 with interest at
the rate of 12% per annum from December 1, 1965 until paid, and the amount deposited by
Felimon Cuevas with the Court shall be applied in partial payment of this judgment. Otherwise,
should Filipinas Investment and Finance Corporation be able to take possession of the said
Datsun Bluebird car, the amount deposited by the plaintiff should be returned. Without
pronouncement as to costs.

In Civil Case No. 61651, judgment is rendered in favor of the plaintiff and against the defendant
for P22,041.99, with interest at the rate of 12% per annum from July 10, 1965 until paid, and the
costs of the suit.

SO ORDERED. (pp. 60-61, Records)

26
Not satisfied with the decision of the trial court, respondent Cuevas appealed to the Intermediate Appellate Court
(now Court of Appeals). On July 23, 1969, a resolution was adopted by the Intermediate Appellate Court denying
the appeal (p. 88, Records,). An entry of judgment was issued, stating that on August 4, 1969, the judgment had
become final and executory.

On September 18, 1967, petitioner corporation filed a motion for execution of the aforementioned judgment. A
writ of execution was therefore issued by the trial court on December 26, 1969 directing respondent Cuevas and
Citadel Insurance & Surety Co. to return the two Datsun Bluebird cars to petitioner corporation or, if the same
cannot be delivered, to pay P7,577.10 and P7,729.44 with interest. Thus, respondent Cuevas delivered on
February 17, 1970 the two Datsun cars in question to the Sheriff of Manila. However, on February 18, 1970,
petitioner corporation filed with the trial court a manifestation and motion to enforce the execution of the
judgment by proceeding on the re-delivery bond posted by respondent Cuevas and/or to execute on the
judgment for value. Due to petitioner's suggestions, the deputy sheriff made a supplemental return to the writ of
execution stating that the petitioner corporation accepted the two Datsun cars not as a satisfaction of the writ,
but to levy the same on execution under the writ of execution in Civil Case No. 61651 of the CFI of Manila and/or
to execute on the judgment for value in view of the alleged depreciation of the said cars. Respondent Cuevas
and Citadel Insurance and Surety Co., Inc. filed an urgent motion to declare the judgment satisfied and to recall
the writ of execution. After the parties were given sufficient opportunity to make several motions, oppositions and
memoranda, the trial court issued orders declaring the judgment already satisfied and directing the clerk of court
to return the amount deposited by Cuevas. This caused the filing of a motion for reconsideration by petitioner
and opposition and the filing of memoranda by the parties. On July 31, 1970, the court set aside its order
declaring the judgment satisfied and directed the reception of the evidence concerning the value of the Datsun
cars.

On September 25, 1970, the trial court denied the motion of petitioner corporation and ruled that the petitioner
corporation had not filed any application for damages while the case was pending before the trial court or before
appeal by respondent Cuevas was perfected, or before the judgment of the trial court had become final and
executory; that since the judgment of the court had long become final, the claim of petitioner corporation against
the bond of Citadel Insurance and Surety Co., Inc. can no longer be entertained, as the court had already lost its
jurisdiction to amend the decision in the case to include the award of damages against the re-delivery bond. The
trial court stated that although petitioner corporation had alleged proofs to show the substantial deterioration of
the two Datsun cars in support of its claim for the execution of the judgment for value, these proofs had already
been presented and made known to the court before the latter issued its orders on April 21, 1970 declaring the
judgment satisfied. Moreover, the court also declared that petitioner corporation had abandoned and waived its
right to present more concrete and acceptable evidence concerning the value of the two Datsun cars, when it
failed to comply with the order of the court on July 31, 1970 directing the introduction of such evidence. The trial
court finally concluded that the total evidence on record was not sufficient to prove the assertion of petitioner
corporation that the two cars had substantially deteriorated, and that the judgment had in fact already been
satisfied (pp. 85-103, Records).

On May 10, 1971, petitioner corporation filed Civil Case No. 83110 against respondent Cuevas based on two
causes of action, to wit: firstly, to recover the unpaid sum of P12,450.92 plus interest, on the promissory note for
P38,135.36 made on November 21, 1963 by respondent Cuevas in favor of Ace Consolidated, Inc.; and
secondly, to collect the remaining sum of P12,254.45 on the promissory note for P12,540.00 made on December
9, 1963, in favor of Ace Consolidated, Inc.

On September 27, 1971, petitioner filed a motion for the dismissal of the first cause of action in its complaint,
which motion was granted by the trial court. Thereafter, on September 27, 1971, petitioner filed another
complaint docketed as Civil Case No. 84625, to collect the amount of P12,450.92 with interest, based on the
promissory note executed on November 22, 1963, in favor of Ace Consolidated, Incorporated.

Answering the complaints in Civil Cases Nos. 83110 and 84625, respondent Cuevas admitted the genuineness
and due execution of the two promissory notes, but asserted as affirmative defenses, that the said promissory
notes had already been litigated in Civil Cases Nos. 61514 and 61651; that the decision rendered therein had
become final and had already been executed, so that the present suits are now barred on the ground of res
judicata and/or, that the obligations of the respondent under the two promissory notes had long been
extinguished by payment or satisfaction of prior judgment.

27
On December 15, 1971, the trial court issued an order for consolidation of cases nos. 83110 and 84625 upon
motion of petitioner. After consolidation and trial on the merits of both cases, the trial court rendered a decision
on August 14, 1975, the dispositive portion of which states:

IN VIEW OF THE FOREGOING, the Court dismisse[s] the complaints and sentences the plaintiff
to pay the defendant P3,000.00 by way of attorney's fees as well as the costs.

SO ORDERED. (pp. 66-67, Records)

From the aforequoted decision, petitioner corporation appealed to the Intermediate Appellate Court (now Court
of Appeals). On October 28, 1983, the respondent appellate court rendered judgment, the dispositive portion of
which provides:

WHEREFORE, with the elimination of the P3,000.00 awarded to defendant-appellee by way of

attorney's fees, the judgment appealed from is AFFIRMED, without pronouncement as to costs.

SO ORDERED. (p. 23, Rollo)

Hence, the petition was filed, with the petitioner assigning the following errors:

a. The pronouncement in the Decision (on a question of law) that the Decisions in Civil Cases
61514 and 61651 are res adjudicata to Civil Cases 83110 and 84625;

b. The palpable error in the finding of respondent the Honorable Intermediate Appellate Court
that the Promissory Notes, dated November 22, 1963 and December 9, 1963, subject of Civil
Cases 83110 and 84625 were previously discharged or satisfied; p. 7, Rollo).

Petitioner corporation contends that the doctrine of res judicata cannot apply in this case because Civil Cases
Nos. 83110 and 84625 are independent ordinary actions for sums of money, not the continuation or enforcement
of the previous unsatisfied judgment in Civil Case No. 61514. It further submits that the first case, namely No.
61514 is for annulment of document, whereas the action in cases nos. 83110 and 84625 are for sums of money
arising from unpaid promissory notes.

We find the petitioner's contentions devoid of merit.

Rule 39, Section 49 of the Rules of Court expressly provides:

Sec. 49. Effect of judgments. The effect of a judgement or final order rendered by a court or
judge of the Philippines, having jurisdiction to pronounce the judgment or order, may be as
follows:

xxx xxx xxx

(b) In other cases, the judgment or order is, with respect to the matter directly adjudged or as to
any other matter that could have been raised in relation thereto, conclusive between the parties
and their successors in interest by title subsequent to the commencement of the action or special
proceeding, litigating for the same thing and under the same title and in the same capacity;

The aforequoted provision enunciates the rule of res judicata or bar by prior judgment. The doctrine of res
judicata is an old axiom of the law, dictated by wisdom and sanctified by age, and is founded on the broad
principle that it is to the interest of the public that there should be an end to litigation by the same parties over a
subject once fully and fairly adjudicated (Fernandez v. Sebido, et al., 70 Phil. 151).

For the doctrine to apply, the following elements should concur, to wit: 1) the presence of a final former
judgment; 2) the former judgment was rendered by a court having jurisdiction over the subject matter and the
parties; 3) the former judgment is a judgment on the merits; and 4) there is between the first and the second
actions, identity of parties, of subject matter, and of cause of action (Eternal Gardens Memorial Parks Corp. v.
28
Court of Appeals, G.R. 73794, September 19, 1988; Carandang v. Venturanza, No. L- 41940, November 29,
1984, 133 SCRA 437).

There is no dispute as to the existence of and compliance with the first three elements of res judicata in the case
at bar. The question left to be resolved is whether the subject matters and causes of action in Cases Nos. 61514
and 61651 and Cases Nos. 83110 and 84625 are identical.

The subject matter of an action is the matter or thing from which the dispute has arisen, and ordinarily, it is the
property or the contract or any other thing subject of the controversy. Records disclose that the controversy in
Civil Cases Nos. 61514 and 61651 arose from the sale of motor vehicles evidenced by the following: 1) a
promissory note dated November 21, 1963 executed by Felimon Cuevas in the amount of P38,135,26, secured
by a chattel mortgage over one Nissan truck subject of the sale, in favor of Ace Consolidated, Inc. petitioner's
predecessor in interest; 2) another promissory note dated November 22, 1963 executed by respondent Cuevas
in favor of Ace Consolidated, Inc., in the amount of P12,540.00, secured by a chattel mortgage over one Datsun
Bluebird car subject of the sale; and 3) another promissory note dated November 9, 1963, executed by
respondent Cuevas in favor of Ace Consolidated, Inc., petitioner's predecessor in interest, in the amount of Pl
2,540.00 secured by a chattel mortgage over another Datsun Bluebird car subject of the sale. The same
promissory notes dated November 21, 1963 and December 9, 1963 were again the subjects of the action filed
by petitioner in Civil Case No. 83110. Likewise, the promissory note dated November 22, 1963, which was taken
up previously in Cases Nos. 61514 and 61651 is brought again in issue in Case No. 84625. Thus, the Identity of
subject matter in both cases cannot be gainsaid. As such, the judgment in Civil Cases Nos. 61514 and 61651
are conclusive as to all questions litigated and decided therein.

In determining whether the causes of action are Identical so as to warrant application of the rule of res judicata,
the following question is a sufficient criterion: would the same evidence support and establish both the present
and former causes of action? If so, the prior judgment is a bar; otherwise, it is not. Moreover, there is Identity of
causes of action when the judgment sought will be inconsistent with the prior judgment (Tan v. Valdehueza, et
al., L-38745, August 6, 1975, 66 SCRA 61).

The complaint filed by respondent Cuevas in Civil Case No. 61514 was to ask the court to enjoin petitioner
corporation from taking possession or foreclosing the chattel mortgages on the two Datsun Bluebird cars
claiming that the payment of his obligations was up-to-date, and to order petitioner to apply the payments made
by Cuevas to the two cars and not to the Nissan truck. Petitioner corporation filed its answer with counterclaim
seeking a writ of replevin or the payment of unpaid installments with interest from the sale of the two Datsun
Bluebird cars, which claims were granted by the trial court from the evidence presented. Further, petitioner
corporation instituted Civil Case No. 61651 to collect the unpaid installment price on the Nissan truck bought by
Cuevas. These were the same reliefs sought by petitioner corporation in its complaints in Cases Nos. 83110 and
84625, that is, the payment of unpaid installments based on the promissory notes executed by respondent
Cuevas from the sale of the Nissan truck and the two Datsun cars. Although petitioner corporation was merely
the defendant in the first action (Case No. 61514), it interposed several counterclaims which were tried and
determined in the lower court. Hence, notwithstanding a difference in the forms of the two actions, the doctrine
of res judicata will be applied where it appears that the parties in the suits were in effect "litigating for the same
thing." A party cannot, by varying the form of action, or adopting a different method of presenting his case,
escape the operation of the principle that one and the same cause of action shall not be twice litigated between
the same parties or their privies (Peñalosa v. Tuason, 22 Phil. 303).

Petitioner further submits that there is no substantial distinction between a new action for a sum of money and
an action for revival of judgment; that instead of filing an action for revival of the previous judgment in Case No.
61514, it had chosen to file new suits for sum of money based on the same promissory notes dated November
22, 1963 and December 9, 1963, because the five-year period from the finality of the judgment in Case No.
61514 had already elapsed, without the said judgment having been satisfied.

The foregoing contentions are untenable. Section 6 of Rule 39 explicitly provides:

Section 6. Execution by motion or by independent action.-A judgment may be executed on

motion within five (5) years from the date of its entry or from the date it becomes final and
executory. After the lapse of such time, and before it is barred by the statute of limitations, a
judgment may be enforced by action.

29
The only action contemplated in the above-quoted provision of law is one for revival of judgment and not a new
action based on the original controversy decided upon with finality. The action for revival of judgment is a new
and independent action wherein the cause of action is the judgment itself and not the merits of the action upon
which the judgment sought to be enforced is rendered. Its purpose is not to re-examine and re-try the issues
already decided but only to revive the judgment (Azotes v. Blanco, 85 Phil. 90).

We held in the case of Compania General de Tabacos v. Martinez, 29 Phil. 515, and reiterated in the later case
of Estonina v. Southern Marketing Corporation, etc., et al., G.R. No. 61375, November 23, 1988, the following
rule:

After the lapse of five years, however, the judgment creditor can no longer enforce the judgment
by process issuing as his request from the court which rendered it. It is then beyond the power of
that court to issue execution upon its judgment. The judgment is, after that period of time,
reduced to a mere right of action in favor of the person whom it favors which must be enforced,
as are all other ordinary actions, by the institution of a complaint in the regular form. Being a final
judgment of a court, it is of course, conclusive as to the controversy between the parties up to the
time of its rendition. By the mere pleading of the judgment and its introduction in evidence, the
plaintiff effectually blocks all investigation into the merits of the original controversy. But, being a
mere right of action, it is subject to defenses and counterclaims which may have arisen
subsequent to the date it became effective, as, for instance, prescription, which bars an action
upon a judgment after ten years (Sec. 43, par. 1, Code Civ. Proc.) or payment; or counterclaims
arising out of transactions not connected with the former controversy. In other words, the
judgment creditor finds himself in the position of any other litigant and is under an equal
necessity of proving his case, although his trouble in doing so may be less due to the
conclusiveness of the evidence which he has to offer, that is, his judgment. . . .

Anent its second assigned error, petitioner claims that respondent appellate court erred in finding that the
promissory notes, subject of Civil Cases Nos. 83110 and 84625 were previously discharged or satisfied.

Such allegation is unfounded, baseless and also misleading. In fact the respondent court found petitioner's
second assignment of error meritorious and concluded in its decision that the aforementioned judgment in Case
No. 61514 had not been satisfied and duly executed because while the two (2) Datsun Bluebird cars were
delivered, the same were in dilapidated condition. But despite this finding, respondent court ruled that petitioner
cannot be allowed to file the action anew because it is barred by the principle of res judicata (p. 23, Rollo)
Clearly, petitioner committed a mistake in alleging that there was such an error committed by the respondent
appellate court.

ACCORDINGLY, the petition is hereby DENIED and the decision of the respondent Intermediate Appellate Court
(now Court of Appeals) dated October 28, 1983 is AFFIRMED.

SO ORDERED

G.R. No. L-54108 January 17, 1984

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
COURT OF TAX APPEALS and SMITH KLINE & FRENCH OVERSEAS CO. (PHILIPPINE
BRANCH), respondents.

The Solicitor General for petitioner.

Siguion Reyna, Montecillo & Ongsiako and J.C. Castañeda, Jr. and E.C. Alcantara for respondents.

AQUINO, J.:

30
This case is about the refund of a 1971 income tax amounting to P324,255. Smith Kline and French Overseas
Company, a multinational firm domiciled in Philadelphia, Pennsylvania, is licensed to do business in the
Philippines. It is engaged in the importation, manufacture and sale of pharmaceuticals drugs and chemicals.

In its 1971 original income tax return, Smith Kline declared a net taxable income of P1,489,277 (Exh. A) and
paid P511,247 as tax due. Among the deductions claimed from gross income was P501,040 ($77,060) as its
share of the head office overhead expenses. However, in its amended return filed on March 1, 1973, there was
an overpayment of P324,255 "arising from underdeduction of home office overhead" (Exh. E). It made a formal
claim for the refund of the alleged overpayment.

It appears that sometime in October, 1972, Smith Kline received from its international independent auditors,
Peat, Marwick, Mitchell and Company, an authenticated certification to the effect that the Philippine share in the
unallocated overhead expenses of the main office for the year ended December 31, 1971 was actually $219,547
(P1,427,484). It further stated in the certification that the allocation was made on the basis of the percentage of
gross income in the Philippines to gross income of the corporation as a whole. By reason of the new adjustment,
Smith Kline's tax liability was greatly reduced from P511,247 to P186,992 resulting in an overpayment
of P324,255.

On April 2, 1974, without awaiting the action of the Commissioner of Internal Revenue on its claim Smith Kline
filed a petition for review with the Court of Tax Appeals.

In its decision of March 21, 1980, the Tax Court ordered the Commissioner to refund the overpayment or grant a
tax credit to Smith Kline. The Commissioner appealed to this Court.

The governing law is found in section 37 of the old National Internal Revenue Code, Commonwealth Act No.
466, which is reproduced in Presidential Decree No. 1158, the National Internal Revenue Code of 1977 and
which reads:

SEC. 37. Income form sources within the Philippines. —

xxx xxx xxx

(b) Net income from sources in the Philippines. — From the items of gross income specified in
subsection (a) of this section there shall be deducted the expenses, losses, and other deductions
properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other
deductions which cannot definitely be allocated to some item or class of gross income. The
remainder, if any, shall be included in full as net income from sources within the Philippines.

xxx xxx xxx

Revenue Regulations No. 2 of the Department of Finance contains the following provisions on the deductions to
be made to determine the net income from Philippine sources:

SEC. 160. Apportionment of deductions. — From the items specified in section 37(a), as being
derived specifically from sources within the Philippines there shall be deducted the expenses,
losses, and other deductions properly apportioned or allocated thereto and a ratable part of any
other expenses, losses or deductions which can not definitely be allocated to some item or class
of gross income. The remainder shall be included in full as net income from sources within the
Philippines. The ratable part is based upon the ratio of gross income from sources within the
Philippines to the total gross income.

Example: A non-resident alien individual whose taxable year is the calendar year, derived gross
income from all sources for 1939 of P180,000, including therein:

Interest on bonds of a domestic corporation P9,000

Dividends on stock of a domestic corporation 4,000

31
 Royalty for the use of patents within the Philippines 12,000

Gain from sale of real property located within the Philippines 11,000

Total P36,000

that is, one-fifth of the total gross income was from sources within the Philippines. The remainder
of the gross income was from sources without the Philippines, determined under section 37(c).

The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount
of P8,000 is properly allocated to income from sources within the Philippines and the amount of
P40,000 is properly allocated to income from sources without the Philippines.

The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A
ratable part thereof, based upon the relation of gross income from sources within the Philippines
to the total gross income, shall be deducted in computing net income from sources within the
Philippines. Thus, these are deducted from the P36,000 of gross income from sources within the
Philippines expenses amounting to P14,000 [representing P8,000 properly apportioned to the
income from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses
which could not be allocated to any item or class of gross income.] The remainder, P22,000, is
the net income from sources within the Philippines.

From the foregoing provisions, it is manifest that where an expense is clearly related to the production of
Philippine-derived income or to Philippine operations (e.g. salaries of Philippine personnel, rental of office
building in the Philippines), that expense can be deducted from the gross income acquired in the Philippines
without resorting to apportionment.

The overhead expenses incurred by the parent company in connection with finance, administration, and
research and development, all of which direct benefit its branches all over the world, including the Philippines,
fall under a different category however. These are items which cannot be definitely allocated or Identified with
the operations of the Philippine branch. For 1971, the parent company of Smith Kline spent $1,077,739. Under
section 37(b) of the Revenue Code and section 160 of the regulations, Smith Kline can claim as its deductible
share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross
income, worldwide, of the multinational corporation.

In his petition for review, the Commissioner does not dispute the right of Smith Kline to avail itself of section
37(b) of the Tax Code and section 160 of the regulations. But the Commissioner maintains that such right is not
absolute and that as there exists a contract (in this case a service agreement) which Smith Kline has entered
into with its home office, prescribing the amount that a branch can deduct as its share of the main office's
overhead expenses, that contract is binding.

The Commissioner contends that since the share of the Philippine branch has been fixed at $77,060, Smith
Kline itself cannot claim more than the said amount. To allow Smith Kline to deduct more than what was
expressly provided in the agreement would be to ignore its existence. It is a cardinal rule that a contract is the
law between the contracting parties and the stipulations therein must be respected unless these are proved to
be contrary to law, morals, good customs and public policy. There being allegedly no showing to the contrary,
the provisions thereof must be followed.

The Commissioner also argues that the Tax Court erred in relying on the certification of Peat, Marwick, Mitchell
and Company that Smith Kline is entitled to deduct P1,427,484 ($219,547) as its allotted share and that Smith
Kline has not presented any evidence to show that the home office expenses chargeable to Philippine
operations exceeded $77,060.

On the other hand, Smith Kline submits that the contract between itself and its home office cannot amend tax
laws and regulations. The matter of allocated expenses which are deductible under the law cannot be the
subject of an agreement between private parties nor can the Commissioner acquiesce in such an agreement.

32
Smith Kline had to amend its return because it is of common knowledge that audited financial statements are
generally completed three or four months after the close of the accounting period. There being no financial
statements yet when the certification of January 11, 1972 was made the treasurer could not have correctly
computed Smith Kline's share in the home office overhead expenses in accordance with the gross income
formula prescribed in section 160 of the Revenue Regulations. What the treasurer certified was a mere estimate.

Smith Kline likewise submits that it has presented ample evidence to support its claim for refund. To this end, it
has presented before the Tax Court the authenticated statement of Peat, Marwick, Mitchell and Company to
show that since the gross income of the Philippine branch was P7,143,155 ($1,098,617) for 1971 as per audit
report prepared by Sycip, Gorres, Velayo and Company, and the gross income of the corporation as a whole
was $6,891,052, Smith Kline's share at 15.94% of the home office overhead expenses was P1,427,484
($219,547) (Exh. G to G-2, BIR Records, 4-5).

Clearly, the weight of evidence bolsters its position that the amount of P1,427,484 represents the correct ratable
share, the same having been computed pursuant to section 37(b) and section 160.

In a manifestation dated July 19, 1983, Smith Kline declared that with respect to its share of the head office
overhead expenses in its income tax returns for the years 1973 to 1981, it deducted its ratable share of the total
overhead expenses of its head office for those years as computed by the independent auditors hired by the
parent company in Philadelphia, Pennsylvania U.S.A., as soon as said computations were made available to it.

We hold that Smith Kline's amended 1971 return is in conformity with the law and regulations. The Tax Court
correctly held that the refund or credit of the resulting overpayment is in order.

WHEREFORE, the decision of the Tax Court is hereby affirmed. No costs.

SO ORDERED

33