G.R. No. 108576 January 20, 1999

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.THE COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP., respondents.

 

MARTINEZ, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of

Appeals (CA) 1 which affirmed the ruling of the Court of Tax Appeals (CTA) 2 that

private respondent A. Soriano Corporation's (hereinafter ANSCOR) redemption and exchange of the stocks of its foreign stockholders cannot be considered as "essentially equivalent to a distribution of taxable dividends" under, Section 83(b) of the 1939 Internal Revenue Act. 3

The undisputed facts are as follows:

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and

controlled by the family of Don Andres, who are all non-resident aliens. 4 In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued. 5

On September 12, 1945, ANSCOR's authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders waived in

favor of the former their pre-emptive rights to subscribe to the new issues. 6 This increased his subscription to 14,963 common shares. 7 A month later, 8 Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR. 

9 Both sons are foreigners. 10

By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between

1949 and December 20, 1963. 11 On December 30, 1964 Don Andres died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares 12 — 50,495 of which are original issues and the balance of 134.659 shares as stock dividend declarations. 13

Correspondingly, one-half of that shareholdings or

92,577 14 shares were transferred to his wife, Doña Carmen Soriano, as her

conjugal share. The other half formed part of his estate. 15

A day after Don Andres died, ANSCOR increased its capital stock to P20M 16 and in 1966 further increased it to P30M. 17 In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate 18 and Doña Carmen from ANSCOR. Hence, increasing

their accumulated shareholdings to 138,867 and 138,864 19 common shares each. 20

On December 28, 1967, Doña Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be considered as a tax

avoidance scheme 21under Section 367 of the 1954 U.S. Revenue Act. 22 By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. 23

In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization

scheme and not tax avoidance. 24 Consequently, 25 on March 31, 1968 Doña Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares, for the remaining 11,140 preferred shares,

thus reducing its (the estate) common shares to 127,727. 26

On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November 1968, the Board further increased ANSCOR's capital

stock to P75M divided into 150,000 preferred shares and 600,000 common shares. 27 About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres' estate, 28 further reducing the latter's common shareholdings to 19,727. As stated in the Board Resolutions, ANSCOR's business purpose for both redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared. 29

In 1973, after examining ANSCOR's books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to

Sections 53 and 54 of the 1939 Revenue Code, 30 for the year 1968 and the second quarter of 1969 based on the

transactions of exchange 31 and redemption of stocks. 31The Bureau of Internal Revenue (BIR) made

the corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree (P.D.) 23 32 which were amended by P.D.'s 67 and 157. 33 However, petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which

ANSCOR was assessed. 34ANSCOR's subsequent protest on the assessments was denied in 1983 by petitioner. 35

Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks. In its decision, the Tax Court reversed petitioner's ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned

assessments. 36 In a petition for review the CA as mentioned, affirmed the ruling of the CTA. 37 Hence, this petition.

The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue

Act 38 which provides:

Sec. 83. Distribution of dividends or assets by corporations. —

(b) Stock dividends — A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend atsuch time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied)

Specifically, the issue is whether ANSCOR's redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as "essentially equivalent to the distribution of taxable dividend" making the proceeds thereof taxable under the provisions of the above-quoted law.

Petitioner contends that the exchange transaction a tantamount to "cancellation" under Section 83(b) making the proceeds thereof taxable. It also argues that the Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under the "net effect test," the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two transactions, pursuant to Section 53 and 54 of the

1939 Revenue Act. 39

ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from Doña Carmen based on the two transactions, because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the event the

company would declare cash dividends, 40 and to (b) subsequently "filipinized" ownership of ANSCOR, as allegedly, envisioned by Don Andres. 41

 It likewise invoked the amnesty provisions of P.D. 67.

We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances

of each case.42 The findings of facts of a special court (CTA) exercising particular expertise on the subject of tax, generally binds this Court, 

43 considering that it is substantially

similar to the findings of the CA which is the final arbiter of questions of facts. 44 The issue in this case does not

only deal with facts but whether the law applies to a particular set of facts. Moreover, this Court is not necessarily bound by the lower courts' conclusions of law drawn from such facts. 45

AMNESTY:

We will deal first with the issue of tax amnesty. Section 1 of P.D. 67 46 provides:

1. In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests or any other acquisitions from any source whatsoever which are taxable under the National Internal Revenue Code, as amended, realized here or abroad by any taxpayer, natural or judicial; the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to such disclosures under the National Internal Revenue Code, the Revised

Penal Code, the Anti-Graft and Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and regulations on Immigration and Deportation, or any other applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax of ten (10%) per centum on such previously untaxed income or wealth, is hereby imposed, subject to the following conditions: (conditions omitted) [Emphasis supplied].

The decree condones "the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liable arising from or incident to" (voluntary) disclosures under the NIRC of previously untaxed income and/or wealth "realized here or abroad by any taxpayer, natural or juridical."

May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An

income taxpayer covers all persons who derive taxable income. 47 ANSCOR was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such, it is being held liable in its capacity as a withholding agent and not its personality as a taxpayer.

In the operation of the withholding tax system, the withholding agent is the payor, a separate entity

acting no more than an agent of the government for the collection of the tax 48 in order to ensure its payments;49 the payer is the taxpayer — he is the person subject to tax impose by law; 

50 and the payee is the taxing authority. 51 In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer, 52 because the income tax is still impose on and due from the latter. The agent is not liable for the tax as no wealth flowed into him — he earned no income. The Tax Code only makes the agent personally liable for the

tax 53arising from the breach of its legal duty to withhold as distinguish from its duty to pay tax since:

the government's cause of action against the withholding is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon

the taxpayer. 54

Not being a taxpayer, a withholding agent, like ANSCOR in this transaction is not protected by the amnesty under the decree.

Codal provisions on withholding tax are mandatory and must be complied with by the withholding

agent. 55 The taxpayer should not answer for the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be deemed to have evaded the tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail tax evasion and give tax evaders a chance to reform, 56 it was deemed administratively feasible to grant tax amnesty in certain instances. In addition, a "tax amnesty, much like a tax

exemption, is never favored nor presumed in law and if granted by a statute, the term of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority. 57 The rule

on strictissimi juris equally applies. 58 So that, any doubt in the application of an amnesty law/decree should be resolved in favor of the taxing authority.

Furthermore, ANSCOR's claim of amnesty cannot prosper. The implementing rules of P.D. 370 which expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to wit:

Sec. 4. Cases not covered by amnesty. — The following cases are not covered by the amnesty subject of these regulations:

xxx xxx xxx

(2) Tax liabilities with or without assessments, on withholding tax at source provided under Section 53 and 54 of the National Internal Revenue Code, as amended; 59

ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not covered by the amnesty.

TAX ON STOCK DIVIDENDS

General Rule

Sec. 83(b) of the 1939 NIRC was taken from the Section 115(g)(1) of the U.S. Revenue Code of

1928. 60 It laid down the general rule known as the proportionate

test 61 wherein stock dividends once issued form part of the capital and, thus, subject to income tax. 62 Specifically, the general rule states that:

A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.

Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to "stock dividends" only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to its

recipient. 63 So that the mere issuance thereof is not yet subject to income tax 64 as they are nothing but an "enrichment through increase in value of capital investment." 

65 As capital, the stock dividends postpone the realization of profits because the "fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution." 66 Income in tax law is "an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment." 67 It means cash or its equivalent. 68 It is gain derived and severed

from capital, 69 from labor or from both combined 70 — so that to tax a stock dividend would be to tax a capital increase rather than the income. 

71 In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. 

72 As capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth.73 The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction. 74

The Exception

However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied).

In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber 75 (that pro ratastock dividends are not taxable income), the exempting clause above quoted was added because provision corporation found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was lust delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the effects of taxation.

Thus, to plug the loophole — the exempting clause was added. It provides that the redemption or cancellation of stock dividends, depending on the "time" and "manner" it was made, is essentially equivalent to a distribution of taxable dividends," making the proceeds thereof "taxable income" "to the extent it represents profits". The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made

use of as a device for the actual distribution of cash dividends, which is taxable. 76 Thus,

the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment by distributing earnings to its shareholders in two transactions — a pro rata stock dividend followed by a pro rata redemption — that would have the

same economic consequences as a simple dividend. 77

Although redemption and cancellation are generally considered capital transactions, as such. they are not subject to tax. However, it does not necessarily mean that a shareholder may

not realize a taxable gain from such transactions. 78 Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the

exclusive owner thereof and can exercise the freedom of choice. 79Having realized gain from that redemption, the income earner cannot escape income tax. 

80

As qualified by the phrase "such time and in such manner," the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock

dividend. 81 So that, whether the amount distributed in the redemption should be treated as the equivalent of a "taxable dividend" is a question of fact, 82 which is determinable on "the basis of the particular facts of the transaction in question. 

83 No decisive test can be used to determine the application of the exemption under Section 83(b). The use of the words "such manner" and "essentially equivalent" negative any idea that a weighted formula can resolve a crucial issue — Should the distribution be treated as taxable dividend. 84 On this aspect, American courts developed certain recognized criteria, which includes the following: 

85

1) the presence or absence of real business purpose,

2) the amount of earnings and profits available for the declaration of a regular dividends and the corporation's past record with respect to the declaration of dividends,

3) the effect of the distribution, as compared with the declaration of regular dividend,

4) the lapse of time between issuance and redemption, 86

5) the presence of a substantial surplus 87

 and a generous supply of cash which invites suspicion as does a meager policy in relation both to current

earnings and accumulated surplus, 88

REDEMPTION AND CANCELLATION

For the exempting clause of Section, 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and (c) the "time and manner" of the transaction makes it "essentially equivalent to a distribution of taxable dividends." Of these, the most important is the third.

Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock 89 in exchange for property, whether or not the acquired stock is cancelled, retired or held in the treasury.90 Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before. The redemption of stock dividends previously issued is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed

shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon.

It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the time of the last redemption, the original common shares

owned by the estate were only 25,247.5 91 This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits 92such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine — wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. 

93 Once capital, it is always capital. 94 That doctrine was intended for the protection of corporate creditors. 95

With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the manner of both the issuance and the redemption. The "time" element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares is a method usually adopted to accomplish the

end sought. 96 Was this transaction used as a "continuing plan," "device" or "artifice" to evade payment of tax? It is necessary to determine the "net effect" of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. 

97 The "net effect" test is not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be reached. 98 It is also important to know whether the issuance of stock dividends was dictated by legitimate business reasons, the presence of which might negate a tax evasion plan. 

99

The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not

related, for the redemption to be considered a legitimate tax scheme. 100 Redemption cannot be used as a cloak to distribute corporate earnings. 

101 Otherwise, the

apparent intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has been ruled that:

[A]n operation with no business or corporate purpose — is a mere devise which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to

transfer a parcel of corporate shares to a stockholder.102

Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be

applicable if the redeemed shares were issued with bona fide business purpose, 103 which is judged after each and every step of the transaction have been considered and the whole transaction does not amount to a tax evasion scheme.

ANSCOR invoked two reasons to justify the redemptions — (1) the alleged "filipinization" program and (2) the reduction of foreign exchange remittances in case cash dividends are declared. The Court is not concerned with the wisdom of these purposes but on their relevance to the whole transaction which can be inferred from the outcome thereof. Again, it is the "net effect rather than the

motives and plans of the taxpayer or his corporation"104 that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result. 105 It also applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or avoiding tax on dividends. 

106 The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining "dividend equivalence". 107 Such purposes may be material only upon the issuance of the stock dividends. The test of taxability under the exempting clause, when it provides "such time and manner" as would make the redemption "essentially equivalent to the distribution of a taxable dividend", is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not deemed "realize" until the fruit has fallen or been plucked from the tree.

The three elements in the imposition of income tax are: (1) there must be gain or and profit, (2) that

the gain or profit is realized or received, actually or constructively, 108 and (3) it is not exempted by law or treaty from income tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comesfrom. 

109

As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the

stockholder's separate property. 110 Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is supported by legitimate business reasons would defeat the very purpose of imposing tax on income. Such argument would open the door for income earners not to pay tax so long as the person from whom the income was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of Section 83(b) would be made to depend not on the income of the taxpayer, but on the business purposes of a third party (the corporation herein) from whom the income was earned. This is absurd, illogical and impractical considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the legitimacy of business reasons that every income earner may interposed. It is not administratively feasible and cannot therefore be allowed.

The ruling in the American cases cited and relied upon by ANSCOR that "the redeemed shares are

the equivalent of dividend only if the shares were not issued for genuine business purposes", 111 or the "redeemed shares have been issued by a corporation bona fide" 112 bears no relevance in determining the non-taxability of the proceeds of redemption ANSCOR, relying heavily and applying said cases, argued that so long as the redemption is supported by valid corporate purposes the proceeds are not subject to tax. 113 The adoption by the courts below 114 of such argument is misleading if not misplaced. A review of the cited American cases shows that the presence or absence of "genuine business purposes" may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporation's acquisition of its own shares under Section 41 of the Corporation Code, 115such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons, the redemption becomes suspicious which exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences. 116

The two purposes invoked by ANSCOR, under the facts of this case are no excuse for its tax liability. First, the alleged "filipinization" plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a separate entity, the corporation can act only through its Board of

Directors. 117 The Board Resolutions authorizing the redemptions state only one

purpose — reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970's. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCOR's alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCOR's foreign stockholders contrary to its "filipinization" plan. This would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres' foreign heirs.

Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayer's liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was shown that income was generated therefrom.

Thirdly, ANSCOR argued that to treat as "taxable dividend" the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to

intervening purchase, i.e. those who buys the stock dividends after their issuance. 118 Such argument,

however, bears no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend equivalence test depends

on such "time and manner" of the transaction and its net effect. The undisclosed lien 119 may be unfair to a

subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber.

After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As "taxable dividend" under Section

83(b), it is part of the "entire income" subject to tax under Section 22 in relation to Section 21 120 of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in "gross income". As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES 121

Exchange is an act of taking or giving one thing for another involving 122 reciprocal transfer 

123 and is generally considered as a taxable transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to reorganizations. 

124

Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doña Carmen's shares were exchanged for the whole 150.000 preferred shares. Thereafter, both the Don Andres estate and Doña Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized — it was a mere corporate paper transaction. It would have been different, if the

exchange transaction resulted into a flow of wealth, in which case income tax may be imposed. 125

Reclassification of shares does not always bring any substantial alteration in the subscriber's proportional interest. But the exchange is different — there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to a pro

rata division of profits. 126 Preferred stocks are those which entitle the shareholder to some priority on dividends and asset distribution. 127

Both shares are part of the corporation's capital stock. Both stockholders are no different from ordinary investors who take on the same investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the

enterprise. 128 Moreover, under the doctrine of equality of shares — all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided that the Articles of Incorporation is silent on such differences. 129

In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscriber's rights and privileges — which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a subscriber disposes of his

entire interest and not when there is still maintenance of proprietary interest. 130

WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCOR's redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects.

SECOND DIVISION   COMMISSIONER OF INTERNAL G.R. No. 179063REVENUE,Petitioner, Present:

Quisumbing, J., Chairperson,- versus - Carpio,

Carpio Morales,Bersamin, andAbad, JJ.

UNITED COCONUT PLANTERSBANK, Promulgated:Respondent.October 23, 2009x ---------------------------------------------------------------------------------------- x 

DECISION  ABAD, J.:  

This is an action involving a disputed assessment for deficiencies in the payment of creditable withholding tax and documentary stamps tax due from a foreclosure sale.

 The Facts and the Case

 Respondent United Coconut Planters Bank (UCPB) granted loans

of P68,840,000.00 and P335,000,000.00 to George C. Co, Go Tong Electrical Supply Co., Inc., and Tesco Realty Co. that the borrowers caused to be secured by several real estate mortgages. When the latter later failed to pay their loans, UCPB filed a petition for extrajudicial foreclosure of the mortgaged properties. Pursuant to that petition, on December 31, 2001 a notary public for Manila held a public

auction sale of the mortgaged properties. UCPB made the highest winning bid of P504,785,000.00 for the whole lot.

 On January 4, 2002 the notary public submitted the Certificate of Sale to the

Executive Judge of Regional Trial Court (RTC) of Manila for his approval But, onFebruary 18, 2002 the executive judge returned it with instruction to the notary public to explain an inconsistency in the tax declaration of one mortgaged property. The executive judge further ordered the notary public to show proof of payment of the Sheriffs percentage of the bid price. The notary public complied. On March 1, 2002 the executive judge finally signed the certificate of sale and approved its issuance to UCPB as the highest bidder.

 On June 18, 2002 UCPB presented the certificate of sale to the Register of

Deeds of Manila for annotation on the transfer certificates of title of the foreclosed properties. On July 5, 2002 the bank paid creditable withholding taxes (CWT) of P28,640,700.00 and documentary stamp taxes (DST) of P7,160,165.00 in relation to the extrajudicial foreclosure sale. It then submitted an affidavit of consolidation of ownership to the Bureau of Internal Revenue (BIR) with proof of tax payments and other documents in support of the banks application for a tax clearance certificate and certificate authorizing registration.

 Petitioner Commissioner of Internal Revenue (CIR), however, charged

UCPB with late payment of the corresponding DST and CWT, citing Section 2.58 of Revenue Regulation 2-98, which stated that the CWT must be paid within 10 days after the end of each month, and Section 5 of Revenue Regulation 06-01, which required payment of DST within five days after the close of the month when the taxable document was made, signed, accepted or transferred. These taxes accrued upon the lapse of the redemption period of the mortgaged properties. The CIR pointed out that the mortgagor, a juridical person, had three months after foreclosure within which to redeem the properties

 The CIR theorized that the three-month redemption period was to be counted

from the date of the foreclosure sale. Here, he said, the redemption period lapsed three months from December 31, 2001 or on March 31, 2002. Thus, UCPB was in default for having paid the CWT and DST only on July 5, 2002. For this reason the CIR issued a Pre-Assessment Notice and, subsequently, a Final Assessment

Notice to UCPB for deficiency CWT of P8,617,210.00 and deficiency DST ofP2,173,051.75.

 UCPB protested the assessment. It claimed that the redemption period

lapsed on June 1, 2002 or three months after the executive judge of Manila approved the issuance of the certificate of sale. Foreclosure under Section 47 of the General Banking Law, said UCPB, referred to the date of approval by the executive judge, and not the date of the auction sale. But the CIR denied UCPBs protest, prompting UCPB to file a petition for review with the CTA in CTA Case 7164.

 On July 26, 2006 the CTA Second Division set aside the decision of the CIR

and held that the redemption period lapsed three months after the executive judge approved the certificate of sale. It said that foreclosure under the law referred to the whole process of foreclosure which included the approval and issuance of the certificate of sale. There was no sale to speak of which could be taxed prior to such approval and issuance. Since the executive judge approved the issuance only onMarch 1, 2002, the redemption period expired on June 1, 2002. Hence, UCPBs payments of CWT and DST in early July were well within the prescribed period. On appeal to the CTA En Banc in CTA EB 234, the latter affirmed the decision of the Second Division on June 5, 2007. With the denial of its motion for reconsideration, petitioner has taken recourse to this Court via a petition for review on certiorari. 

Issue 

The key issue in this case is whether or not the three-month redemption period for juridical persons should be reckoned from the date of the auction sale.

 Ruling

 The CIR argues that he has the more reasonable position: the redemption

period should be reckoned from the date of the auction sale for, otherwise, the taxing authority would be left at the mercy of the executive judge who may unnecessarily delay the approval of the certificate of sale and thus prevent the early payment of taxes.

 But the Supreme Court had occasion under its resolution in Administrative

Matter 99-10-05-0 to rule that the certificate of sale shall issue only upon approval of the executive judge who must, in the interest of fairness, first determine that the requirements for extrajudicial foreclosures have been strictly followed. For instance, inUnited Coconut Planters Bank v. Yap,[9] this Court sustained a judges resolution requiring payment of notarial commission as a condition for the issuance of the certificate of sale to the highest bidder.

 Here, the executive judge approved the issuance of the certificate of sale to UCPB on March 1, 2002. Consequently, the three-month redemption period ended only onJune 1, 2002. Only on this date then did the deadline for payment of CWT and DST on the extrajudicial foreclosure sale become due. 

Under Section 2.58 of Revenue Regulation 2-98, the CWT return and payment become due within 10 days after the end of each month, except for taxes withheld for the month of December of each year, which shall be filed on or before January 15 of the following year. On the other hand, under Section 5 of Revenue Regulation 06-01, the DST return and payment become due within five days after the close of the month when the taxable document was made, signed, accepted, or transferred. The BIR confirmed and summarized the above provisions under Revenue Memorandum Circular 58-2008 in this manner:

 [I]f the property is an ordinary asset of the mortgagor, the creditable expanded withholding tax shall be due and paid within ten (10) days following the end of the month in which the redemption period expires. x x x Moreover, the payment of the documentary stamp tax and the filing of the return thereof shall have to be made within five (5) days from the end of the month when the redemption period expires.  UCPB had, therefore, until July 10, 2002 to pay the CWT and July 5,

2002 to pay the DST. Since it paid both taxes on July 5, 2002, it is not liable for deficiencies.Thus, the Court finds no reason to reverse the decision of the CTA. 

Besides, on August 15, 2008, the Bureau of Internal Revenue issued Revenue Memorandum Circular 58-2008  which clarified among others, the time within which to reckon the redemption period of real estate mortgages. It reads:

 For purposes of reckoning the one-year redemption period in the

case of individual mortgagors, or the three-month redemption period for juridical persons/mortgagors, the same shall be reckoned from the date of the confirmation of the auction sale which is the date when the certificate of sale is issued.

  The CIR must have in the meantime conceded the unreasonableness of the previous position it had taken on this matter.WHEREFORE, the petition is DENIED. SO ORDERED.

THIRD DIVISION

 SUPREME TRANSLINER, INC., MOISES C. ALVAREZ and PAULITA S. ALVAREZ,Petitioners,

- versus -

BPI FAMILY SAVINGS BANK, INC.,Respondent.

G.R. No. 165617

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

BPI FAMILY SAVINGS BANK, INC.,Petitioner,

- versus -

SUPREME TRANSLINER,INC., MOISES C. ALVAREZand PAULITA S. ALVAREZ,Respondents.

G.R. No. 165837

Present:

BRION, J.,Chairperson,BERSAMIN,ABAD,VILLARAMA, JR., andSERENO, JJ.

Promulgated:

February 25, 2011x- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -x 

DECISION 

VILLARAMA, JR., J.: This case involves the question of the correct redemption price payable to a mortgagee bank as purchaser of the property in a foreclosure sale.On April 24, 1995, Supreme Transliner, Inc. represented by its Managing Director, Moises C. Alvarez, and Paulita S. Alvarez, obtained a loan in the amount ofP9,853,000.00 from BPI Family Savings Bank with a 714-square meter lot covered by Transfer Certificate of Title No. T-79193 in the name of Moises C. Alvarez and Paulita S. Alvarez, as collateral.

For non-payment of the loan, the mortgage was extrajudicially foreclosed and the property was sold to the bank as the highest bidder in the public auction conducted by the Office of the Provincial Sheriff of Lucena City. On August 7, 1996, a Certificate of Sale was issued in favor of the bank and the same was registered on October 1, 1996.

Before the expiration of the one-year redemption period, the mortgagors notified the bank of their intention to redeem the property. Accordingly, the following Statement of Account was prepared by the bank indicating the total amount due under the mortgage loan agreement:

x x x x

Balance of PrincipalAdd: Interest DueLate Payment ChargesMRIFire InsuranceForeclosure Expenses

P 9,551,827.641,417,761.24

155,546.250.000.00

155,817.23Sub-totalLess: Unapplied Payment

P 11,280,952.36908,241.01

Total Amount Due As Of 08/07/96(Auction Date)

10,372,711.35

Add: Attorneys Fees (15%) 1,555,906.70Liquidated Damages (15%) 1,555,906.70Interest on P 10,372,711.35 from 08/07/96to 04/07/97 (243 days) at 17.25% p.a. 1,207,772.58x x x x

Asset Acquired Expenses:

Documentary Stamps 155,595.00Capital Gains Tax 518,635.57Foreclosure Fee 207,534.23Registration and Filing Fee 23,718.00Addl. Registration & Filing Fee 660.00 906,142.79

Interest on P 906,142.79 from 08/07/96 to 04/07/97 (243 days)at 17.25% p.a. 105,509.00

Cancellation Fee 300.00

Total Amount Due As Of 04/07/97(Subject to Audit) P  15,704,249.12

x x x x

The mortgagors requested for the elimination of liquidated damages and reduction of attorneys fees and interest (1% per month) but the bank refused. On May 21, 1997, the mortgagors redeemed the property by paying the sum of P15,704,249.12. A Certificate of Redemption was issued by the bank on May 27, 1997.

On June 11, 1997, the mortgagors filed a complaint against the bank to recover the allegedly unlawful and excessive charges totaling P5,331,237.77, with prayer for damages and attorneys fees, docketed as Civil Case No. 97-72 of the Regional Trial Court of Lucena City, Branch 57.

In its Answer with Special and Affirmative Defenses and Counterclaim, the bank asserted that the redemption price reflecting the stipulated interest, charges and/or expenses, is valid, legal and in accordance with documents duly signed by the mortgagors. The bank further contended that the claims are deemed waived and the mortgagors are already estopped from questioning the terms and conditions of their contract.

On September 30, 1997, the bank filed a motion to set the case for hearing on the special and affirmative defenses by way of motion to dismiss. The trial court denied the motion on January 8, 1998 and also denied the banks motion for reconsideration. The bank elevated the matter to the Court of Appeals (CA-G.R. SP No. 47588) which dismissed the petition for certiorari on February 26, 1999.

On February 14, 2002, the trial court rendered its deci dismissing the complaint and the banks counterclaims. The trial court held that plaintiffs-mortgagors are bound by the terms of the mortgage loan documents which clearly provided for the payment of the following interest, charges and expenses: 18% p.a. on the loan, 3% post-default penalty, 15% liquidated damages, 15% attorneys fees and collection and legal costs. Plaintiffs-mortgagors claim that they paid the redemption price demanded by the defendant bank under extreme pressure was rejected by the trial court since there was active negotiation for the final redemption price between the banks representatives and plaintiffs-mortgagors who at the time had legal advice from their counsel, together with Orient Development Banking Corporation which committed to finance the redemption.

According to the trial court, plaintiffs-mortgagors are estopped from questioning the correctness of the redemption price as they had freely and voluntarily signed the letter-agreement prepared by the defendant bank, and along with Orient Bank expressed their conformity to the terms and conditions therein, thus:

May 14, 1997 ORIENT DEVELOPMENT BANKING CORPORATION7th Floor Ever Gotesco Corporate CenterC.M. Recto Avenue corner Matapang StreetManila Attention: MS. AIDA C. DELA ROSASenior Vice-President

Gentlemen:

This refers to your undertaking to settle the account of SUPREME TRANS LINER, INC. and spouses MOISES C. ALVAREZ and PAULITA S. ALVAREZ, covering the real estate property located in the Poblacion, City of Lucena under TCT No. T-79193 which was foreclosed by BPI FAMILY SAVINGS BANK, INC.

With regard to the proposed refinancing of the account, we interpose no objection to the annotation of your mortgage lien thereon subject to the following conditions: 

1. That all expenses for the registration of the annotation of mortgage and other incidental registration and cancellation expenses shall be borne by the borrower.

2. That you will recognize our mortgage liens as first and superior until the loan with us is fully paid.

3. That you will annotate your mortgage lien and pay us the full amount to close the loan within five (5) working days from the receipt of the titles. If within this period, you have not registered the same and paid us in full, you will immediately and unconditionally return the titles to us without need of demand, free from liens/encumbrances other than our lien.

4. That in case of loss of titles, you will undertake and shoulder the cost of re-issuance of a new owners titles.

5. That we will issue the Certificate of Redemption after full payment of P15,704,249.12. representing the outstanding balance of the loan as of May 15, 1997 including interest and other charges

thereof within a period of five (5) working days after clearance of the check payment.

6. That we will release the title and the Certificate of Redemption and other pertinent papers only to your authorized representative with complete authorization and identification.

7. That all expenses related to the cancellation of your annotated mortgage lien should the Bank be not fully paid on the period above indicated shall be charged to you.

If you find the foregoing conditions acceptable, please indicate your conformity on the space provided below and return to us the duplicate copy.

 Very truly yours, BPI FAMILY BANKBY: (SGD.) LOLITA C. CARRIDOManager 

C O N F O R M E : 

ORIENT DEVELOPMENT BANKING CORPORATION 

(SGD.) AIDA C. DELA ROSASenior Vice President

  

C O N F O R M E : 

SUPREME TRANS LINER, INC. 

(SGD.) MOISES C. ALVAREZ/PAULITA S. ALVAREZMortgagors

As to plaintiffs-mortgagors contention that the amounts representing attorneys fees and liquidated damages were already included in the P10,372,711.35 bid price, the trial court said this was belied by their own evidence, the Statement of Account showing the breakdown of the redemption price as computed by the defendant bank.

The mortgagors appealed to the CA (CA-G.R. CV No. 74761) which, by Decision dated April 6, 2004 reversed the trial court and decreed as follows:

WHEREFORE, foregoing considered, the appealed decision is hereby REVERSED and SET ASIDE. A new one is hereby entered as follows:

1. Plaintiffs-appellants complaint for damages against defendant-appellee is hereby REINSTATED;

2. Defendant-appellee is hereby ORDERED to return to plaintiffs-appellees (sic) the invalidly collected amount of P3,111,813.40 plus six (6) percent legal interest from May 21, 1997 until fully returned;

3. Defendant-appellee is hereby ORDERED to pay plaintiffs-appellees (sic) the amount of P100,000.00 as moral damages, P100,000.00 as exemplary damages and P100,000.00 as attorneys fees;

4. Costs against defendant-appellee.

SO ORDERED.

The CA ruled that attorneys fees and liquidated damages were already included in the bid price of P10,372,711.35 as per the recitals in the Certificate of Sale that said amount was paid to the foreclosing mortgagee to satisfy not only the principal loan but also interest and penalty charges, cost of publication and expenses of the foreclosure proceedings. These penalty charges consist of 15% attorneys fees and 15% liquidated damages which the bank imposes as penalty in cases of violation of the terms of the mortgage deed. The total redemption price thus should only be P12,592,435.72 and the bank should return the amount of P3,111,813.40 representing attorneys fees and liquidated damages. The appellate court further stated that the mortgagors cannot be deemed estopped to question the propriety of the charges because from the very start they had repeatedly questioned the imposition of attorneys fees and liquidated damages and were merely constrained to pay the demanded redemption price for fear that the redemption period will expire without them redeeming their property.

By Resolution dated October 12, 2004, the CA denied the parties respective motions for reconsideration.

Hence, these petitions separately filed by the mortgagors and the bank.

In G.R. No. 165617, the petitioners-mortgagors raise the single issue of whether the foreclosing mortgagee should pay capital gains tax upon execution of the certificate of sale, and if paid by the mortgagee, whether the same should be

shouldered by the redemptioner. They specifically prayed for the return of all asset-acquired expenses consisting of documentary stamps tax, capital gains tax, foreclosure fee, registration and filing fee, and additional registration and filing fee totaling P906,142.79, with 6% interest thereon from May 21, 1997.

On the other hand, the petitioner bank in G.R. No. 165837 assails the CA in holding that

1. the Certificate of Sale, the bid price of P10,372,711.35 includes penalty charges and as such for purposes of computing the redemption price petitioner can no longer impose upon the private respondents the penalty charges in the form of 15% attorneys fees and the 15% liquidated damages in the aggregate amount of P3,111,813.40, although the evidence presented by the parties show otherwise.

 2. private respondents cannot be considered to be under estoppel to question

the propriety of the aforestated penalty charges despite the fact that, as found by the Honorable Trial Court, there was very active negotiation between the parties in the computation of the redemption price culminating into the signing freely and voluntarily by the petitioner, the private respondents and Orient Bank, which financed the redemption of the foreclosed property, of Exhibit 3, wherein they mutually agreed that the redemption price is in the sum of P15,704,249.12.

3. petitioner [to] pay private respondents damages in the aggregate amount of P300,000.00 on the ground that the former acted in bad faith in the imposition upon them of the aforestated penalty charges, when in truth it is entitled thereto as the law and the contract expressly provide and that private respondents agreed to pay the same.

Act No. 337, otherwise known as the General Banking Act, governs in cases where the mortgagee is a bank. Said provision reads:

 SEC. 78. x x x In the event of foreclosure, whether judicially or extrajudicially, of any mortgage on real estate which is security for any loan granted before the passage of this Act or under the provisions of this Act, the mortgagor or debtor whose real property has been sold at public auction, judicially or extrajudicially, for the full or partial payment of an obligation to any bank, banking or credit institution, within the purview of this Act shall have the right, within one year after the sale of the real estate as a result of the foreclosure of the respective mortgage, to redeem the property by paying the amount fixed by the court in the order of execution, or the amount due under the mortgage deed, as the case may be,with interest thereon at the rate specified in the mortgage, and all the costs, and judicial and other expenses incurred by the bank or institution concerned by reason of the execution and sale and as a result of the custody

of said property less the income received from the property. x x x x (Emphasis supplied.)

Under the Mortgage Loan Agreement, petitioners-mortgagors undertook to pay the attorneys fees and the costs of registration and foreclosure. The following contract terms would show that the said items are separate and distinct from the bid price which represents only the outstanding loan balance with stipulated interest thereon.

23. Application of Proceeds of Foreclosure Sale. The proceeds of sale of the mortgaged property/ies shall be applied as follows:

a) To the payment of the expenses and cost of foreclosure and sale, including the attorneys fees as herein provided;

b) To the satisfaction of all interest and charges accruing upon the obligations herein and hereby secured.

c) To the satisfaction of the principal amount of the obligations herein and hereby secured.

d) To the satisfaction of all other obligations then owed by the Borrower/Mortgagor to the Bank or any of its subsidiaries/affiliates such as, but not limited to BPI Credit Corporation; or to Bank of the Philippine Islands or any of its subsidiaries/affiliates such as, but not limited to BPI Leasing Corporation, BPI Express Card Corporation, BPI Securities Corporation and BPI Agricultural Development Bank; and

e) The balance, if any, to be due to the Borrower/Mortgagor.

x x x x

31. Attorneys Fees: In case the Bank should engage the services of counsel to enforce its rights under this Agreement, the Borrower/Mortgagor shall pay an amount equivalent to fifteen (15%) percent of the total amount claimed by the Bank, which in no case shall be less than P2,000.00, Philippine currency, plus costs, collection expenses and disbursements allowed by law, all of which shall be secured by this mortgage.

Additionally, the Disclosure Statement on Loan/Credit Transaction also duly signed by the petitioners-mortgagors provides:

10. ADDITIONAL CHARGES IN CASE CERTAIN STIPULATIONS ARE NOT MET BY THE BORROWER a. Post Default Penalty 3.00% per monthb. Attorneys Services 15% of sum due but not less than P2,000.00

c. Liquidated Damages 15% of sum due but not less than P10,000.00d. Collection & Legal Cost As provided by the Rules of Courte. Others (Specify)

As correctly found by the trial court, that attorneys fees and liquidated damages were not yet included in the bid price of P10,372,711.35 is clearly shown by the Statement of Account as of April 4, 1997 prepared by the petitioner bank and given to petitioners-mortgagors. On the other hand, par. 23 of the Mortgage Loan Agreement indicated that asset acquired expenses were to be added to the redemption price as part of costs and other expenses incurred by the mortgagee bank in connection with the foreclosure sale. Coming now to the issue of capital gains tax, we find merit in petitioners-mortgagors argument that there is no legal basis for the inclusion of this charge in the redemption price. Under Revenue Regulations (RR) No. 13-85 (December 12, 1985), every sale or exchange or other disposition of real property classified as capital asset under Section 34(a) of the Tax Code shall be subject to the final capital gains tax. The term sale includes pacto de retro and other forms of conditional sale.Section 2.2 of Revenue Memorandum Order (RMO) No. 29-86 (as amended by RMO No. 16-88 and as further amended by RMO Nos. 27-89 and 6-92) states that these conditional sales necessarily include mortgage foreclosure sales (judicial and extrajudicial foreclosure sales). Further, for real property foreclosed by a bank on or afterSeptember 3, 1986, the capital gains tax and documentary stamp tax must be paid before title to the property can be consolidated in favor of the bank.

Under Section 63 of Presidential Decree No. 1529 otherwise known as the Property Registration Decree, if no right of redemption exists, the certificate of title of the mortgagor shall be cancelled, and a new certificate issued in the name of the purchaser. But where the right of redemption exists, the certificate of title of the mortgagor shall not be cancelled, but the certificate of sale and the order confirming the sale shall be registered by brief memorandum thereof made by the Register of Deeds upon the certificate of title. In the event the property is redeemed, the certificate or deed of redemption shall be filed with the Register of Deeds, and a brief memorandum thereof shall be made by the Register of Deeds on the certificate of title.

It is therefore clear that in foreclosure sale, there is no actual transfer of the mortgaged real property until after the expiration of the one-year redemption

period as provided in Act No. 3135 and title thereto is consolidated in the name of the mortgagee in case of non-redemption. In the interim, the mortgagor is given the option whether or not to redeem the real property. The issuance of the Certificate of Sale does not by itself transfer ownership.

RR No. 4-99 issued on March 16, 1999, further amends RMO No. 6-92 relative to the payment of Capital Gains Tax and Documentary Stamp Tax on extrajudicial foreclosure sale of capital assets initiated by banks, finance and insurance companies.

SEC. 3. CAPITAL GAINS TAX.

(1) In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. x x x

(2) In case of non-redemption, the capital gains [tax] on the foreclosure sale imposed under Secs. 24(D)(1) and 27(D)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the expiration of the one-year period of redemption provided for under Sec. 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within thirty (30) days from the expiration of the said one-year redemption period.

SEC. 4. DOCUMENTARY STAMP TAX.

(1) In case the mortgagor exercises his right of redemption, the transaction shall only be subject to the P15.00 documentary stamp tax imposed under Sec. 188 of the Tax Code of 1997 because no land or realty was sold or transferred for a consideration.

(2) In case of non-redemption, the corresponding documentary stamp tax shall be levied, collected and paid by the person making, signing, issuing, accepting, or transferring the real property wherever the document is made, signed, issued, accepted or transferred where the property is situated in the Philippines. x x x (Emphasis supplied.)

Although the subject foreclosure sale and redemption took place before the effectivity of RR No. 4-99, its provisions may be given retroactive effect in this case.

Section 246 of the NIRC of 1997 states:

SEC. 246. Non-Retroactivity of Rulings. Any revocation, modification, or reversal of any of the rules and regulations promulgated in accordance with the preceding Sections or any of the rulings or circulars promulgated by the Commissioner shall not be given retroactive application if the revocation, modification, or reversal will be prejudicial to the taxpayers, except in the following cases:

(a) where the taxpayer deliberately misstates or omits material facts from his return or in any document required of him by the Bureau of Internal Revenue;

(b) where the facts subsequently gathered by the Bureau of Internal Revenue are materially different from the facts on which the ruling is based; or

(c) where the taxpayer acted in bad faith.

In this case, the retroactive application of RR No. 4-99 is more consistent with the policy of aiding the exercise of the right of redemption. As the Court of Tax Appeals concluded in one case, RR No. 4-99 has curbed the inequity of imposing a capital gains tax even before the expiration of the redemption period [since] there is yet no transfer of title and no profit or gain is realized by the mortgagor at the time of foreclosure sale but only upon expiration of the redemption period. In his commentaries, De Leon expressed the view that while revenue regulations as a general rule have no retroactive effect, if the revocation is due to the fact that the regulation is erroneous or contrary to law, such revocation shall have retroactive operation as to affect past transactions, because a wrong construction of the law cannot give rise to a vested right that can be invoked by a taxpayer.

Considering that herein petitioners-mortgagors exercised their right of redemption before the expiration of the statutory one-year period, petitioner bank is not liable to pay the capital gains tax due on the extrajudicial foreclosure sale. There was no actual transfer of title from the owners-mortgagors to the foreclosing bank. Hence, the inclusion of the said charge in the total redemption price was unwarranted and the corresponding amount paid by the petitioners-mortgagors should be returned to them.

WHEREFORE, premises considered, both petitions are PARTLY GRANTED.

In G.R. No. 165617, BPI Family Savings Bank, Inc. is hereby ordered to RETURN the amounts representing capital gains and documentary stamp taxes as reflected in the Statement of Account To Redeem as of April 7, 1997, to

petitioners Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez, and to retain only the sum provided in RR No. 4-99 as documentary stamps tax due on the foreclosure sale.

In G.R. No. 165837, petitioner BPI Family Savings Bank, Inc. is hereby declared entitled to the attorneys fees and liquidated damages included in the total redemption price paid by Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez. The sums awarded as moral and exemplary damages, attorneys fees and costs in favor of Supreme Transliner, Inc., Moises C. Alvarez and Paulita Alvarez are DELETED.

The Decision dated April 6, 2004 of the Court of Appeals in CA-G.R. CV No. 74761 is accordingly MODIFIED.

SO ORDERED.

G.R. No. 102967           February 10, 2000

BIBIANO V. BAÑAS, JR., petitioner, vs.

COURT OF APPEALS, AQUILINO T. LARIN, RODOLFO TUAZON AND PROCOPIO TALON, respondents.

QUISUMBING, J.:

For review is the Decision of the Court of Appeals in CA-C.R. CV No. 17251 promulgated on November 29, 1991. It affirmed in toto the judgment of the Regional Trial Court (RTC), Branch 39, Manila, in Civil Case No. 82-12107. Said judgment disposed as follows:

FOR ALL THE FOREGOING CONSIDERATIONS, this Court hereby renders judgment DISMISSING the complaint against all the defendants and ordering plaintiff [herein petitioner] to pay defendant Larin the amount of P200,000.00 (Two Hundred Thousand Pesos) as actual and compensatory damages; P200,000.00 as moral damages; and P50,000.00 as exemplary damages and attorneys fees of P100,000.00.1

The facts, which we find supported by the records, have been summarized by the Court of Appeals as follows:

On February 20, 1976, petitioner, Bibiano V. Bañas Jr. sold to Ayala Investment Corporation (AYALA), 128,265 square meters of land located at Bayanan, Muntinlupa, for two million, three hundred eight thousand, seven hundred seventy (P2,308,770.00) pesos. The Deed of Sale provided that upon the signing of the contract AYALA shall pay four hundred sixty-one thousand, seven hundred fifty-four (P461,754.00) pesos. The balance of one million, eight hundred forty-seven thousand and sixteen (P1,847,016.00) pesos was to be paid in four equal consecutive annual installments, with twelve (12%) percent interest per annum on the outstanding balance. AYALA issued one promissory note covering four equal annual installments. Each periodic payment of P461,754.00 pesos shall be payable starting on February 20, 1977, and every year thereafter, or until February 20, 1980.

The same day, petitioner discounted the promissory note with AYALA, for its face value of P1,847,016.00, evidenced by a Deed of Assignment signed by the petitioner and AYALA. AYALA issued nine (9) checks to petitioner, all dated February 20, 1976, drawn against Bank of the Philippine Islands with the uniform amount of two hundred five thousand, two hundred twenty-four (P205,224.00) pesos.

In his 1976 Income Tax Return, petitioner reported the P461,754 initial payment as income from disposition of capital asset.2

Selling Price of Land P2,308,770.00

Less Initial Payment 461,754.00 3

Unrealized Gain P1,847,016.00

1976 Declaration of Income on Disposition of Capital Asset subject to Tax:

Initial Payment P461,754.00

Less: Cost of land and other incidental Expenses ( 76,547.90)

Income P385,206.10

Income subject to tax (P385,206. 10 x 50%) P192,603.65

In the succeeding years, until 1979, petitioner reported a uniform income of two hundred thirty thousand, eight hundred seventy-seven (P230,877.00) pesos4 as gain from sale of capital asset. In his 1980 income tax amnesty return, petitioner also reported the same amount of P230,877.00 as the realized gain on disposition of capital asset for the year.

On April 11, 1978, then Revenue Director Mauro Calaguio authorized tax examiners, Rodolfo Tuazon and Procopio Talon to examine the books and records of petitioner for the year 1976. They discovered that petitioner had no outstanding receivable from the 1976 land sale to AYALA and concluded that the sale was cash and the entire profit should have been taxable in 1976 since the income was wholly derived in 1976.

Tuazon and Talon filed their audit report and declared a discrepancy of two million, ninety-five thousand, nine hundred fifteen (P2,095,915.00) pesos in petitioner's 1976 net income. They recommended deficiency tax assessment for two million, four hundred seventy-three thousand, six hundred seventy-three (P2,473,673.00) pesos.

Meantime, Aquilino Larin succeeded Calaguio as Regional Director of Manila Region IV-A. After reviewing the examiners' report, Larin directed the revision of the audit report, with instruction to consider the land as capital asset. The tax due was only fifty (50%) percent of the total gain from sale of the property held by the taxpayer beyond twelve months pursuant to Section 345 of the 1977 National Internal Revenue Code (NIRC). The deficiency tax assessment was reduced to nine hundred thirty six thousand, five hundred ninety-eight pesos and fifty centavos (P936,598.50), inclusive of surcharges and penalties for the year 1976.

On June 27, 1980, respondent Larin sent a letter to petitioner informing of the income tax deficiency that must be settled him immediately.

On September 26, 1980, petitioner acknowledged receipt of the letter but insisted that the sale of his land to AYALA was on installment.

On June 8, 1981, the matter was endorsed to the Acting Chief of the Legal Branch of the National Office of the BIR. The Chief of the Tax Fraud Unit recommended the prosecution of a criminal case for conspiring to file false and fraudulent returns, in violation of Section 51 of the Tax Code against petitioner and his accountants, Andres P. Alejandre and Conrado Bañas.

On June 17, 1981, Larin filed a criminal complaint for tax evasion against the petitioner.

On July 1, 1981, news items appeared in the now defunct Evening Express with the headline: "BIR Charges Realtor" and another in the defunct Evening Post with a news item: "BIR raps Realtor, 2 accountants." Another news item also appeared in the July 2, 1981, issue of the Bulletin Today entitled: "3-face P1-M tax evasion raps." All news items mentioned petitioner's false income tax return concerning the sale of land to AYALA.

On July 2, 1981, petitioner filed an Amnesty Tax Return under P.D. 1740 and paid the amount of forty-one thousand, seven hundred twenty-nine pesos and eighty-one centavos (P41,729.81). On November 2, 1981, petitioner again filed an Amnesty Tax Return under P.D. 1840 and paid an additional amount of one thousand, five hundred twenty-five pesos and sixty-two centavos (P1,525.62). In both, petitioner did not recognize that his sale of land to AYALA was on cash basis.

Reacting to the complaint for tax evasion and the news reports, petitioner filed with the RTC of Manila an action6for damages against respondents Larin, Tuazon and Talon for extortion and malicious publication of the BIR's tax audit report. He claimed that the filing of criminal complaints against him for violation of tax laws were improper because he had already availed of two tax amnesty decrees, Presidential Decree Nos. 1740 and 1840.

The trial court decided in favor of the respondents and awarded Larin damages, as already stated. Petitioner seasonably appealed to the Court of Appeals. In its decision of November 29, 1991, the respondent court affirmed the trial court's decision, thus:

The finding of the court a quo that plaintiff-appellant's actions against defendant-appellee Larin were unwarranted and baseless and as a result thereof, defendant-appellee Larin was subjected to unnecessary anxiety and humiliation is therefore supported by the evidence on record.1âwphi1.nêt

Defendant-appellee Larin acted only in pursuance of the authority granted to him. In fact, the criminal charges filed against him in the Tanodbayan and in the City Fiscal's Office were all dismissed.

WHEREFORE, the appealed judgment is hereby AFFIRMED in toto.7

Hence this petition, wherein petitioner raises before us the following queries:

I. WHETHER THE COURT OF APPEALS ERRED IN ITS INTERPRETATION OF PERTINENT TAX LAWS, THUS IT FAILED TO APPRECIATE THE CORRECTNESS AND ACCURACY OF PETITIONER'S RETURN OF THE INCOME DERIVED FROM THE SALE OF THE LAND TO AYALA.

II. WHETHER THE RESPONDENT COURT ERRED IN NOT FINDING THAT THERE WAS AN ALLEGED ATTEMPT TO EXTORT [MONEY FROM] PETITIONER BY PRIVATE RESPONDENTS.

III. WHETHER THE RESPONDENT COURT ERRED IN ITS INTERPRETATION OF PRESIDENTIAL DECREE NOS. 1740 AND 1840, AMONG OTHERS, PETITIONER'S IMMUNITY FROM CRIMINAL PROSECUTION.

IV. WHETHER THE RESPONDENT COURT ERRED IN ITS INTERPRETATION OF WELL-ESTABLISHED DOCTRINES OF THIS HONORABLE COURT AS REGARDS THE AWARD OF ACTUAL, MORAL AND EXEMPLARY DAMAGES IN FAVOR OF RESPONDENT LARIN.

In essence, petitioner asks the Court to resolve seriatim the following issues:

1. Whether respondent court erred in ruling that there was no extortion attempt by BIR officials;

2. Whether respondent court erred in holding that P.D. 1740 and 1840 granting tax amnesties did not grant immunity from tax suits;

3. Whether respondent court erred in finding that petitioner's income from the sale of land in 1976 should be declared as a cash transaction in his tax return for the same year (because the buyer discounted the promissory note issued to the seller on future installment payments of the sale, on the same day of the sale);

4. Whether respondent court erred and committed grave abuse of discretion in awarding damages to respondent Larin.

The first issue, on whether the Court of Appeals erred in finding that there was no extortion, involves a determination of fact. The Court of Appeals observed,

The only evidence to establish the alleged extortion attempt by defendants-appellees is the plaintiff-appellant's self serving declarations.

As found by the court a quo, "said attempt was known to plaintiff-appellant's son-in-law and counsel on record, yet, said counsel did not take the witness stand to corroborate the testimony of plaintiff."8

As repeatedly held, findings of fact by the Court of Appeals especially if they affirm factual findings of the trial court will not be disturbed by this Court, unless these findings are not supported by evidence.9 Similarly, neither should we disturb a finding of the trial court and appellate court that an allegation is not supported by evidence on record. Thus, we agree with the conclusion of respondent court that herein private respondents, on the basis of evidence, could not be held liable for extortion.

On the second issue of whether P.D. Nos. 1740 and 1840 which granted tax amnesties also granted immunity from criminal prosecution against tax offenses, the pertinent sections of these laws state:

P.D. No. 1740. CONDONING PENALTIES FOR CERTAIN VIOLATIONS OF THE INCOME TAX LAW UPON VOLUNTARY DISCLOSURE OF UNDECLARED INCOME FOR INCOME TAX PURPOSES AND REQUIRING PERIODIC SUBMISSION OF NET WORTH STATEMENT.

x x x           x x x           x x x

Sec. 1. Voluntary Disclosure of Correct Taxable Income. — Any individual who, for any or all of the taxable years 1974 to 1979, had failed to file a return is hereby, allowed to file a return for each of the aforesaid taxable years and accurately declare therein the true and correct income, deductions and exemptions and pay the income tax due per return. Likewise, any individual who filed a false or fraudulent return for any taxable year in the period mentioned above may amend his return and pay the correct amount of tax due after deducting the taxes already paid, if any, in the original declaration. (emphasis ours)

x x x           x x x           x x x

Sec. 5. Immunity from Penalties. — Any individual who voluntarily files a return under this Decree and pays the income tax due thereon shall be immune from the penalties, civil or criminal, under the National Internal Revenue Code arising from failure to pay the correct income tax with respect to the taxable years from which an amended return was filed or for

which an original return was filed in cases where no return has been filed for any of the taxable years 1974 to 1979: Provided, however, That these immunities shall not apply in cases where the amount of net taxable income declared under this Decree is understated to the extent of 25% or more of the correct net taxable income. (emphasis ours)

P.D. NO. 1840 — GRANTING A TAX AMNESTY ON UNTAXED INCOME AND/OR WEALTH EARNED OR ACQUIRED DURING THE TAXABLE YEARS 1974 TO 1980 AND REQUIRING THE FILING OF THE STATEMENT OF ASSETS, LIABILITIES, AND NET WORTH.

Sec. 1. Coverage. — In case of voluntary disclosure of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests or any other acquisition from any source whatsoever, realized here or abroad, by any individual taxpayer, which are taxable under the National Internal Revenue Code, as amended, the assessment and collection of all internal revenue taxes, including the increments or penalties on account of non-payment, as well as all civil, criminal or administrative liabilities arising from or incident thereto under the National Internal Revenue Code, are hereby condoned provided that the individual taxpayer shall pay. (emphasis ours) . . .

Sec. 2. Conditions for Immunity. — The immunity granted under Section one of this Decree shall apply only under the following conditions:

a) Such previously untaxed income and/or wealth must have been earned or realized in any of the years 1974 to 1980;

b) The taxpayer must file an amnesty return on or before November 30, 1981, and fully pay the tax due thereon;

c) The amnesty tax paid by the taxpayer under this Decree shall not be less than P1,000.00 per taxable year; and

d) The taxpayer must file a statement of assets, liabilities and net worth as of December 31, 1980, as required under Section 6 hereof. (emphasis ours)

It will be recalled that petitioner entered into a deed of sale purportedly on installment. On the same day, he discounted the promissory note covering the future installments. The discounting seems questionable because ordinarily, when a bill is discounted, the lender (e.g. banks, financial institution) charges or deducts a certain percentage from the principal value as its compensation. Here, the discounting was done by the buyer. On July 2, 1981, two weeks after the filing of the tax evasion complaint against him by respondent Larin on June 17, 1981, petitioner availed of the tax amnesty under P.D. No. 1740. His amended tax return for the years 1974 - 1979 was filed with the BIR office of Valenzuela, Bulacan, instead of Manila where the petitioner's principal office was located. He again availed of the tax amnesty under P.D. No. 1840. His disclosure, however, did not include the income from his sale of land to AYALA on cash basis. Instead he insisted that such sale was on installment. He did not amend his income tax return. He did not pay the tax which was considerably increased by the income derived from the discounting. He did not meet the twin requirements of P.D. 1740 and 1840, declaration of his untaxed income and full payment of tax due thereon. Clearly, the petitioner is not entitled to the benefits of P.D. Nos. 1740 and 1840. The mere filing of tax amnesty return under P.D. 1740 and 1840 does not ipso facto shield him from immunity against prosecution. Tax amnesty is a general pardon to taxpayers who want to start a clean tax slate. It also gives the government a chance to collect uncollected tax from tax evaders without having to go through the tedious process of a tax case. To avail of a tax amnesty granted by the

government, and to be immune from suit on its delinquencies, the tax payer must have voluntarily disclosed his previously untaxed income and must have paid the corresponding tax on such previously untaxed income.10

It also bears noting that a tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by statute, the terms of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority.11 Hence, on this matter, it is our view that petitioner's claim of immunity from prosecution under the shield of availing tax amnesty is untenable.

On the third issue, petitioner asserts that his sale of the land to AYALA was not on cash basis but on installment as clearly specified in the Deed of Sale which states:

That for and in consideration of the sum of TWO MILLION THREE HUNDRED EIGHT THOUSAND SEVEN HUNDRED SEVENTY (P2,308,770.00) PESOS Philippine Currency, to be paid as follows:

1. P461,754.00, upon the signing of the Deed of Sale; and,

2. The balance of P1,847,016.00, to be paid in four (4) equal, consecutive, annual installments with interest thereon at the rate of twelve percent (12%) per annum, beginning on February 20, 1976, said installments to be evidenced by four (4) negotiable promissory notes.12

Petitioner resorts to Section 43 of the NIRC and Sec. 175 of Revenue Regulation No. 2 to support his claim.

Sec. 43 of the 1977 NIRC states,

Installment basis. — (a) Dealers in personal property. — . . .

(b) Sales of realty and casual sales of personalty — In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price exceeding one thousand pesos, or (2) of a sale or other disposition of real property if in either case the initial payments do not exceed twenty-five percentum of the selling price, the income may, under regulations prescribed by the Minister of Finance, be returned on the basis and in the manner above prescribed in this section. As used in this section the term "initial payment" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made. . . . (emphasis ours)

Revenue Regulation No. 2, Section 175 provides,

Sale of real property involving deferred payments. — Under section 43 deferred-payment sales of real property include (1) agreements of purchase and sale which contemplate that a conveyance is not to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as to deferred payments. Such sales either under (a) or (b), fall into two classes when considered with respect to the terms of sale, as follows:

(1) Sales of property on the installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made do not exceed 25 per cent of the selling price;

(2) Deferred-payment sales not on the installment plan, that is sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made exceed 25 per cent of the selling price;

In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the "selling price" but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or of the "total contract price," as those terms are used in section 43 of the Code, in sections 174 and 176 of these regulations, and in this section. The term "initial payments" does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years. Commissions and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the "initial payments," the "total contract price," or the "selling price." The term "initial payments" contemplates at least one other payment in addition to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no payment during the year, the income may not be returned on the installment basis. Income may not be returned on the installment basis where no payment in cash or property, other than evidences of indebtedness of the purchaser, is received during the first year, the purchaser having promised to make two or more payments, in later years.

Petitioner asserts that Sec. 43 allows him to return as income in the taxable years involved, the respective installments as provided by the deed of sale between him and AYALA. Consequently, he religiously reported his yearly income from sale of capital asset, subject to tax, as follows:

Year 1977 (50% of P461,754)

P230,877.00

1978 230,877.00

1979 230,877.00

1980 230,877.00

Petitioner says that his tax declarations are acceptable modes of payment under Section 175 of the Revenue Regulations (RR) No. 2. The term "initial payment", he argues, does not include amounts received by the vendor which are part of the complete purchase price, still due and payable in subsequent years. Thus, the proceeds of the promissory notes, not yet due which he discounted to AYALA should not be included as income realized in 1976. Petitioner states that the original agreement in the Deed of Sale should not be affected by the subsequent discounting of the bill.

On the other hand, respondents assert that taxation is a matter of substance and not of form. Returns are scrutinized to determine if transactions are what they are and not declared to evade taxes. Considering the progressive nature of our income taxation, when income is spread over several installment payments through the years, the taxable income goes down and the tax due correspondingly decreases. When payment is in lump sum the tax for the year proportionately

increases. Ultimately, a declaration that a sale is on installment diminishes government taxes for the year of initial installment as against a declaration of cash sale where taxes to the government is larger.

As a general rule, the whole profit accruing from a sale of property is taxable as income in the year the sale is made. But, if not all of the sale price is received during such year, and a statute provides that income shall be taxable in the year in which it is "received," the profit from an installment sale is to be apportioned between or among the years in which such installments are paid and received.13

Sec. 43 and Sec. 175 says that among the entities who may use the above-mentioned installment method is a seller of real property who disposes his property on installment, provided that the initial payment does not exceed 25% of the selling price. They also state what may be regarded as installment payment and what constitutes initial payment. Initial payment means the payment received in cash or property excluding evidences of indebtedness due and payable in subsequent years, like promissory notes or mortgages, given of the purchaser during the taxable year of sale. Initial payment does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years.14 Such disposition or discounting of receivable is material only as to the computation of the initial payment. If the initial payment is within 25% of total contract price, exclusive of the proceeds of discounted notes, the sale qualifies as an installment sale, otherwise it is a deferred sale.15

Although the proceed of a discounted promissory note is not considered part of the initial payment, it is still taxable income for the year it was converted into cash. The subsequent payments or liquidation of certificates of indebtedness is reported using the installment method in computing the proportionate income16 to be returned, during the respective year it was realized. Non-dealer sales of real or personal property may be reported as income under the installment method provided that the obligation is still outstanding at the close of that year. If the seller disposes the entire installment obligation by discounting the bill or the promissory note, he necessarily must report the balance of the income from the discounting not only income from the initial installment payment.

Where an installment obligation is discounted at a bank or finance company, a taxable disposition results, even if the seller guarantees its payment, continues to collect on the installment obligation, or handles repossession of merchandise in case of default.17 This rule prevails in the United States.18 Since our income tax laws are of American origin,19 interpretations by American courts an our parallel tax laws have persuasive effect on the interpretation of these laws.20 Thus, by analogy, all the more would a taxable disposition result when the discounting of the promissory note is done by the seller himself. Clearly, the indebtedness of the buyer is discharged, while the seller acquires money for the settlement of his receivables. Logically then, the income should be reported at the time of the actual gain. For income tax purposes, income is an actual gain or an actual increase of wealth.21 Although the proceeds of a discounted promissory note is not considered initial payment, still it must be included as taxable income on the year it was converted to cash. When petitioner had the promissory notes covering the succeeding installment payments of the land issued by AYALA, discounted by AYALA itself, on the same day of the sale, he lost entitlement to report the sale as a sale on installment since, a taxable disposition resulted and petitioner was required by law to report in his returns the income derived from the discounting. What petitioner did is tantamount to an attempt to circumvent the rule on payment of income taxes gained from the sale of the land to AYALA for the year 1976.

Lastly, petitioner questions the damages awarded to respondent Larin.

Any person who seeks to be awarded actual or compensatory damages due to acts of another has the burden of proving said damages as well as the amount thereof.22 Larin says the extortion cases filed against him hampered his immediate promotion, caused him strong anxiety and social humiliation. The trial court awarded him two hundred thousand (P200,000,00) pesos as actual damages. However, the appellate court stated that, despite pendency of this case, Larin was given a promotion at the BIR. Said respondent court:

We find nothing on record, aside from defendant-appellee Larin's statements (TSN, pp. 6-7, 11 December 1985), to show that he suffered loss of seniority that allegedly barred his promotion. In fact, he was promoted to his present position despite the pendency of the instant case (TSN, pp. 35-39, 04 November 1985).23

Moreover, the records of the case contain no statement whatsoever of the amount of the actual damages sustained by the respondents. Actual damages cannot be allowed unless supported by evidence on the record.24The court cannot rely on speculation, conjectures or guesswork as to the fact and amount of damages.25 To justify a grant of actual or compensatory damages, it is necessary to prove with a reasonable degree of certainty, the actual amount of loss.26 Since we have no basis with which to assess, with certainty, the actual or compensatory damages counter-claimed by respondent Larin, the award of such damages should be deleted.

Moral damages may be recovered in cases involving acts referred to in Article 2127 of the Civil Code.28 As a rule, a public official may not recover damages for charges of falsehood related to his official conduct unless he proves that the statement was made with actual malice. In Babst, et. al. vs. National Intelligence Board, et. al., 132 SCRA 316, 330 (1984), we reiterated the test for actual malice as set forth in the landmark American case of New York Times vs. Sullivan,29 which we have long adopted, in defamation and libel cases, viz.:

. . . with knowledge that it was false or with reckless disregard of whether it was false or not.

We appreciate petitioner's claim that he filed his 1976 return in good faith and that he had honestly believed that the law allowed him to declare the sale of the land, in installment. We can further grant that the pertinent tax laws needed construction, as we have earlier done. That petitioner was offended by the headlines alluding to him as tax evader is also fully understandable. All these, however, do not justify what amounted to a baseless prosecution of respondent Larin. Petitioner presented no evidence to prove Larin extorted money from him. He even admitted that he never met nor talked to respondent Larin. When the tax investigation against the petitioner started, Larin was not yet the Regional Director of BIR Region IV-A, Manila. On respondent Larin's instruction, petitioner's tax assessment was considered one involving a sale of capital asset, the income from which was subjected to only fifty percent (50%) assessment, thus reducing the original tax assessment by half. These circumstances may be taken to show that Larin's involvement in extortion was not indubitable. Yet, petitioner went on to file the extortion cases against Larin in different fora. This is where actual malice could attach on petitioner's part. Significantly, the trial court did not err in dismissing petitioner's complaints, a ruling affirmed by the Court of Appeals.

Keeping all these in mind, we are constrained to agree that there is sufficient basis for the award of moral and exemplary damages in favor of respondent Larin. The appellate court believed respondent Larin when he said he suffered anxiety and humiliation because of the unfounded charges against him. Petitioner's actions against Larin were found "unwarranted and baseless," and the criminal charges filed against him in the Tanodbayan and City Fiscal's Office were all dismissed.30 Hence, there is adequate support for respondent court's conclusion that moral damages have been proved.

Now, however, what would be a fair amount to be paid as compensation for moral damages also requires determination. Each case must be governed by its own peculiar circumstances.31 On this score, Del Rosario vs.Court of Appeals,32 cites several cases where no actual damages were adjudicated, and where moral and exemplary damages were reduced for being "too excessive," thus:

In the case of PNB v. C.A., [256 SCRA 309 (1996)], this Court quoted with approval the following observation from RCPI v. Rodriguez, viz:

** **. Nevertheless, we find the award of P100,000.00 as moral damages in favor of respondent Rodriguez excessive and unconscionable. In the case of Prudenciado v. Alliance Transport System,Inc. (148 SCRA 440 [1987]) we said: . . . [I]t is undisputed that the trial courts are given discretion to determine the amount of moral damages (Alcantara v. Surro, 93 Phil. 472) and that the Court of Appeals can only modify or change the amount awarded when they are palpably and scandalously excessive "so as to indicate that it was the result of passion, prejudice or corruption on the part of the trial court" (Gellada v. Warner Barnes & Co., Inc., 57 O.G. [4] 7347, 7358; Sadie v. Bacharach Motors Co., Inc., 57 O.G. [4] 636 and Adone v. Bacharach Motor Co., Inc., 57 O.G. 656). But in more recent cases where the awards of moral and exemplary damages are far too excessive compared to the actual loses sustained by the aggrieved party, this Court ruled that they should be reduced to more reasonable amounts. . . . . (Emphasis ours.)

In other words, the moral damages awarded must be commensurate with the loss or injury suffered.

In the same case (PNB v. CA), this Court found the amount of exemplary damages required to be paid (P1,000,000,00) "too excessive" and reduced it to an "equitable level" (P25,000.00).

It will be noted that in above cases, the parties who were awarded moral damages were not public officials. Considering that here, the award is in favor of a government official in connection with his official function, it is with caution that we affirm granting moral damages, for it might open the floodgates for government officials counter-claiming damages in suits filed against them in connection with their functions. Moreover, we must be careful lest the amounts awarded make citizens hesitate to expose corruption in the government, for fear of lawsuits from vindictive government officials. Thus, conformably with our declaration that moral damages are not intended to enrich anyone,33 we hereby reduce the moral damages award in this case from two hundred thousand (P200,000.00) pesos to seventy five thousand (P75,000.00) pesos, while the exemplary damage is set at P25,000.00 only.

The law allows the award of attorney's fees when exemplary damages are awarded, and when the party to a suit was compelled to incur expenses to protect his interest.34 Though government officers are usually represented by the Solicitor General in cases connected with the performance of official functions, considering the nature of the charges, herein respondent Larin was compelled to hire a private lawyer for the conduct of his defense as well as the successful pursuit of his counterclaims. In our view, given the circumstances of this case, there is ample ground to award in his favor P50,000,00 as reasonable attorney's fees.

WHEREFORE, the assailed decision of the Court of Appeals dated November 29, 1991, is hereby AFFIRMED with MODIFICATION so that the award of actual damages are deleted; and that petitioner is hereby ORDERED to pay to respondent Larin moral damages in the amount of

P75,000.00, exemplary damages in the amount of P25,000.00, and attorney's fees in the amount of P50,000.00 only.1âwphi1.nêt

G.R. No. 159647 April 15, 2005

COMMISSIONER OF INTERNAL REVENUE, Petitioners, vs.CENTRAL LUZON DRUG CORPORATION, Respondent.

D E C I S I O N

PANGANIBAN, J.:

The 20 percent discount required by the law to be given to senior citizens is a tax credit, not merely a tax deduction from the gross income or gross sale of the establishment concerned. A tax credit is used by a private establishment only after the tax has been computed; a tax deduction, before the tax is computed. RA 7432 unconditionally grants a tax credit to all covered entities. Thus, the provisions of the revenue regulation that withdraw or modify such grant are void. Basic is the rule that administrative regulations cannot amend or revoke the law.

The Case

Before us is a Petition for Review1 under Rule 45 of the Rules of Court, seeking to set aside the August 29, 2002 Decision2 and the August 11, 2003 Resolution3 of the Court of Appeals (CA) in CA-GR SP No. 67439. The assailed Decision reads as follows:

"WHEREFORE, premises considered, the Resolution appealed from is AFFIRMED in toto. No costs."4

The assailed Resolution denied petitioner’s Motion for Reconsideration.

The Facts

The CA narrated the antecedent facts as follows:

"Respondent is a domestic corporation primarily engaged in retailing of medicines and other pharmaceutical products. In 1996, it operated six (6) drugstores under the business name and style ‘Mercury Drug.’

"From January to December 1996, respondent granted twenty (20%) percent sales discount to qualified senior citizens on their purchases of medicines pursuant to Republic Act No. [R.A.] 7432 and its Implementing Rules and Regulations. For the said period, the amount allegedly representing the 20% sales discount granted by respondent to qualified senior citizens totaled P904,769.00.

"On April 15, 1997, respondent filed its Annual Income Tax Return for taxable year 1996 declaring therein that it incurred net losses from its operations.

"On January 16, 1998, respondent filed with petitioner a claim for tax refund/credit in the amount of P904,769.00 allegedly arising from the 20% sales discount granted by respondent to qualified senior citizens in compliance with [R.A.] 7432. Unable to obtain affirmative response from petitioner,

respondent elevated its claim to the Court of Tax Appeals [(CTA or Tax Court)] via a Petition for Review.

"On February 12, 2001, the Tax Court rendered a Decision5 dismissing respondent’s Petition for lack of merit. In said decision, the [CTA] justified its ruling with the following ratiocination:

‘x x x, if no tax has been paid to the government, erroneously or illegally, or if no amount is due and collectible from the taxpayer, tax refund or tax credit is unavailing. Moreover, whether the recovery of the tax is made by means of a claim for refund or tax credit, before recovery is allowed[,] it must be first established that there was an actual collection and receipt by the government of the tax sought to be recovered. x x x.

‘x x x x x x x x x

‘Prescinding from the above, it could logically be deduced that tax credit is premised on the existence of tax liability on the part of taxpayer. In other words, if there is no tax liability, tax credit is not available.’

"Respondent lodged a Motion for Reconsideration. The [CTA], in its assailed resolution,6 granted respondent’s motion for reconsideration and ordered herein petitioner to issue a Tax Credit Certificate in favor of respondent citing the decision of the then Special Fourth Division of [the CA] in CA G.R. SP No. 60057 entitled ‘Central [Luzon] Drug Corporation vs. Commissioner of Internal Revenue’ promulgated on May 31, 2001, to wit:

‘However, Sec. 229 clearly does not apply in the instant case because the tax sought to be refunded or credited by petitioner was not erroneously paid or illegally collected. We take exception to the CTA’s sweeping but unfounded statement that ‘both tax refund and tax credit are modes of recovering taxes which are either erroneously or illegally paid to the government.’ Tax refunds or credits do not exclusively pertain to illegally collected or erroneously paid taxes as they may be other circumstances where a refund is warranted. The tax refund provided under Section 229 deals exclusively with illegally collected or erroneously paid taxes but there are other possible situations, such as the refund of excess estimated corporate quarterly income tax paid, or that of excess input tax paid by a VAT-registered person, or that of excise tax paid on goods locally produced or manufactured but actually exported. The standards and mechanics for the grant of a refund or credit under these situations are different from that under Sec. 229. Sec. 4[.a)] of R.A. 7432, is yet another instance of a tax credit and it does not in any way refer to illegally collected or erroneously paid taxes, x x x.’"7

Ruling of the Court of Appeals

The CA affirmed in toto the Resolution of the Court of Tax Appeals (CTA) ordering petitioner to issue a tax credit certificate in favor of respondent in the reduced amount of P903,038.39. It reasoned that Republic Act No. (RA) 7432 required neither a tax liability nor a payment of taxes by private establishments prior to the availment of a tax credit. Moreover, such credit is not tantamount to an unintended benefit from the law, but rather a just compensation for the taking of private property for public use.

Hence this Petition.8

The Issues

Petitioner raises the following issues for our consideration:

"Whether the Court of Appeals erred in holding that respondent may claim the 20% sales discount as a tax credit instead of as a deduction from gross income or gross sales.

"Whether the Court of Appeals erred in holding that respondent is entitled to a refund."9

These two issues may be summed up in only one: whether respondent, despite incurring a net loss, may still claim the 20 percent sales discount as a tax credit.

The Court’s Ruling

The Petition is not meritorious.

Sole Issue:

Claim of 20 Percent Sales Discount

as   Tax Credit   Despite   Net Loss

Section 4a) of RA 743210 grants to senior citizens the privilege of obtaining a 20 percent discount on their purchase of medicine from any private establishment in the country.11 The latter may then claim the cost of the discount as a tax credit.12 But can such credit be claimed, even though an establishment operates at a loss?

We answer in the affirmative.

Tax Credit   versus

Tax Deduction

Although the term is not specifically defined in our Tax Code,13 tax credit generally refers to an amount that is "subtracted directly from one’s total tax liability."14 It is an "allowance against the tax itself"15 or "a deduction from what is owed"16 by a taxpayer to the government. Examples of tax credits are withheld taxes, payments of estimated tax, and investment tax credits.17

Tax credit should be understood in relation to other tax concepts. One of these is tax deduction -- defined as a subtraction "from income for tax purposes,"18 or an amount that is "allowed by law to reduce income prior to [the] application of the tax rate to compute the amount of tax which is due."19 An example of a tax deduction is any of the allowable deductions enumerated in Section 3420 of the Tax Code.

A tax credit differs from a tax deduction. On the one hand, a tax credit reduces the tax due, including -- whenever applicable -- the income tax that is determined after applying the corresponding tax rates to taxable income.21 Atax deduction, on the other, reduces the income that is subject to tax22 in order to arrive at taxable income.23 To think of the former as the latter is to avoid, if not entirely confuse, the issue. A tax credit is used only after the tax has been computed; a tax deduction, before.

Tax Liability Required

for   Tax Credit

Since a tax credit is used to reduce directly the tax that is due, there ought to be a tax liability before the tax creditcan be applied. Without that liability, any tax credit application will be useless. There will be no reason for deducting the latter when there is, to begin with, no existing obligation to the government. However, as will be presented shortly, the existence of a tax credit or its grant by law is not the same as the availment or use of such credit. While the grant is mandatory, the availment or use is not.

If a net loss is reported by, and no other taxes are currently due from, a business establishment, there will obviously be no tax liability against which any tax credit can be applied.24 For the establishment to choose the immediate availment of a tax credit will be premature and impracticable. Nevertheless, the irrefutable fact remains that, under RA 7432, Congress has granted without conditions a tax credit benefit to all covered establishments.

Although this tax credit benefit is available, it need not be used by losing ventures, since there is no tax liability that calls for its application. Neither can it be reduced to nil by the quick yet callow stroke of an administrative pen, simply because no reduction of taxes can instantly be effected. By its nature, the tax credit may still be deducted from a future, not a present, tax liability, without which it does not have any use. In the meantime, it need not move. But it breathes.

Prior Tax Payments Not

Required for   Tax Credit

While a tax liability is essential to the availment or use of any tax credit, prior tax payments are not. On the contrary, for the existence or grant solely of such credit, neither a tax liability nor a prior tax payment is needed. The Tax Code is in fact replete with provisions granting or allowing tax credits, even though no taxes have been previously paid.

For example, in computing the estate tax due, Section 86(E) allows a tax credit -- subject to certain limitations -- for estate taxes paid to a foreign country. Also found in Section 101(C) is a similar provision for donor’s taxes -- again when paid to a foreign country -- in computing for the donor’s tax due. The tax credits in both instances allude to the prior payment of taxes, even if not made to our government.

Under Section 110, a VAT (Value-Added Tax)- registered person engaging in transactions -- whether or not subject to the VAT -- is also allowed a tax credit that includes a ratable portion of any input tax not directly attributable to either activity. This input tax may either be the VAT on the purchase or importation of goods or services that is merely due from -- not necessarily paid by -- such VAT-registered person in the course of trade or business; or the transitional input tax determined in accordance with Section 111(A). The latter type may in fact be an amount equivalent to only eight percent of the value of a VAT-registered person’s beginning inventory of goods, materials and supplies, when such amount -- as computed -- is higher than the actual VAT paid on the said items.25 Clearly from this provision, the tax credit refers to an input tax that is either due only or given a value by mere comparison with the VAT actually paid -- then later prorated. No tax is actually paid prior to the availment of such credit.

In Section 111(B), a one and a half percent input tax credit that is merely presumptive is allowed. For the purchase of primary agricultural products used as inputs -- either in the processing of sardines, mackerel and milk, or in the manufacture of refined sugar and cooking oil -- and for the contract price

of public work contracts entered into with the government, again, no prior tax payments are needed for the use of the tax credit.

More important, a VAT-registered person whose sales are zero-rated or effectively zero-rated may, under Section 112(A), apply for the issuance of a tax credit certificate for the amount of creditable input taxes merely due -- again not necessarily paid to -- the government and attributable to such sales, to the extent that the input taxes have not been applied against output taxes.26 Where a taxpayer is engaged in zero-rated or effectively zero-rated sales and also in taxable or exempt sales, the amount of creditable input taxes due that are not directly and entirely attributable to any one of these transactions shall be proportionately allocated on the basis of the volume of sales. Indeed, in availing of such tax credit for VAT purposes, this provision -- as well as the one earlier mentioned -- shows that the prior payment of taxes is not a requisite.

It may be argued that Section 28(B)(5)(b) of the Tax Code is another illustration of a tax credit allowed, even though no prior tax payments are not required. Specifically, in this provision, the imposition of a final withholding tax rate on cash and/or property dividends received by a nonresident foreign corporation from a domestic corporation is subjected to the condition that a foreign tax credit will be given by the domiciliary country in an amount equivalent to taxes that are merely deemed paid.27 Although true, this provision actually refers to the tax credit as a condition only for the imposition of a lower tax rate, not as a deduction from the corresponding tax liability. Besides, it is not our government but the domiciliary country that credits against the income tax payable to the latter by the foreign corporation, the tax to be foregone or spared.28

In contrast, Section 34(C)(3), in relation to Section 34(C)(7)(b), categorically allows as credits, against the income tax imposable under Title II, the amount of income taxes merely incurred -- not necessarily paid -- by a domestic corporation during a taxable year in any foreign country. Moreover, Section 34(C)(5) provides that for such taxes incurred but not paid, a tax credit may be allowed, subject to the condition precedent that the taxpayer shall simply give a bond with sureties satisfactory to and approved by petitioner, in such sum as may be required; and further conditioned upon payment by the taxpayer of any tax found due, upon petitioner’s redetermination of it.

In addition to the above-cited provisions in the Tax Code, there are also tax treaties and special laws that grant or allow tax credits, even though no prior tax payments have been made.

Under the treaties in which the tax credit method is used as a relief to avoid double taxation, income that is taxed in the state of source is also taxable in the state of residence, but the tax paid in the former is merely allowed as a credit against the tax levied in the latter.29 Apparently, payment is made to the state of source, not the state of residence. No tax, therefore, has been previously paid to the latter.

Under special laws that particularly affect businesses, there can also be tax credit incentives. To illustrate, the incentives provided for in Article 48 of Presidential Decree No. (PD) 1789, as amended by Batas Pambansa Blg. (BP) 391, include tax credits equivalent to either five percent of the net value earned, or five or ten percent of the net local content of exports.30 In order to avail of such credits under the said law and still achieve its objectives, no prior tax payments are necessary.

From all the foregoing instances, it is evident that prior tax payments are not indispensable to the availment of atax credit. Thus, the CA correctly held that the availment under RA 7432 did not require prior tax payments by private establishments concerned.31 However, we do not agree with its finding32 that the carry-over of tax creditsunder the said special law to succeeding taxable periods,

and even their application against internal revenue taxes, did not necessitate the existence of a tax liability.

The examples above show that a tax liability is certainly important in the availment or use, not the existence or grant, of a tax credit. Regarding this matter, a private establishment reporting a net loss in its financial statements is no different from another that presents a net income. Both are entitled to the tax credit provided for under RA 7432, since the law itself accords that unconditional benefit. However, for the losing establishment to immediately apply such credit, where no tax is due, will be an improvident usance.

Sections 2.i and 4 of Revenue

Regulations No. 2-94 Erroneous

RA 7432 specifically allows private establishments to claim as tax credit the amount of discounts they grant.33 In turn, the Implementing Rules and Regulations, issued pursuant thereto, provide the procedures for its availment.34 To deny such credit, despite the plain mandate of the law and the regulations carrying out that mandate, is indefensible.

First, the definition given by petitioner is erroneous. It refers to tax credit as the amount representing the 20 percent discount that "shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes."35 In ordinary business language, the tax credit represents the amount of such discount. However, the manner by which the discount shall be credited against taxes has not been clarified by the revenue regulations.

By ordinary acceptation, a discount is an "abatement or reduction made from the gross amount or value of anything."36 To be more precise, it is in business parlance "a deduction or lowering of an amount of money;"37 or "a reduction from the full amount or value of something, especially a price."38 In business there are many kinds of discount, the most common of which is that affecting the income statement39 or financial report upon which theincome tax is based.

Business Discounts

Deducted from   Gross Sales

A cash discount, for example, is one granted by business establishments to credit customers for their prompt payment.40 It is a "reduction in price offered to the purchaser if payment is made within a shorter period of time than the maximum time specified."41 Also referred to as a sales discount on the part of the seller and a purchase discount on the part of the buyer, it may be expressed in such terms as "5/10, n/30."42

A quantity discount, however, is a "reduction in price allowed for purchases made in large quantities, justified by savings in packaging, shipping, and handling."43 It is also called a volume or bulk discount.44

A "percentage reduction from the list price x x x allowed by manufacturers to wholesalers and by wholesalers to retailers"45 is known as a trade discount. No entry for it need be made in the manual or computerized books of accounts, since the purchase or sale is already valued at the net price actually charged the buyer.46 The purpose for the discount is to encourage trading or increase sales,

and the prices at which the purchased goods may be resold are also suggested.47 Even a chain discount -- a series of discounts from one list price -- is recorded at net.48

Finally, akin to a trade discount is a functional discount. It is "a supplier’s price discount given to a purchaser based on the [latter’s] role in the [former’s] distribution system."49 This role usually involves warehousing or advertising.

Based on this discussion, we find that the nature of a sales discount is peculiar. Applying generally accepted accounting principles (GAAP) in the country, this type of discount is reflected in the income statement50 as a line item deducted -- along with returns, allowances, rebates and other similar expenses -- from gross sales to arrive at net sales.51 This type of presentation is resorted to, because the accounts receivable and sales figures that arise from sales discounts, -- as well as from quantity, volume or bulk discounts -- are recorded in the manual and computerized books of accounts and reflected in the financial statements at the gross amounts of the invoices.52This manner of recording credit sales -- known as the gross method -- is most widely used, because it is simple, more convenient to apply than the net method, and produces no material errors over time.53

However, under the net method used in recording trade, chain or functional discounts, only the net amounts of the invoices -- after the discounts have been deducted -- are recorded in the books of accounts54 and reflected in the financial statements. A separate line item cannot be shown,55 because the transactions themselves involving both accounts receivable and sales have already been entered into, net of the said discounts.

The term sales discounts is not expressly defined in the Tax Code, but one provision adverts to amounts whose sum -- along with sales returns, allowances and cost of goods sold56 -- is deducted from gross sales to come up with the gross income, profit or margin57 derived from business.58 In another provision therein, sales discountsthat are granted and indicated in the invoices at the time of sale -- and that do not depend upon the happening of any future event -- may be excluded from the gross sales within the same quarter they were given.59 While determinative only of the VAT, the latter provision also appears as a suitable reference point for income tax purposes already embraced in the former. After all, these two provisions affirm that sales discounts are amounts that are always deductible from gross sales.

Reason for the Senior Citizen Discount:

The Law, Not Prompt Payment

A distinguishing feature of the implementing rules of RA 7432 is the private establishment’s outright deduction of the discount from the invoice price of the medicine sold to the senior citizen.60 It is, therefore, expected that for each retail sale made under this law, the discount period lasts no more than a day, because such discount is given -- and the net amount thereof collected -- immediately upon perfection of the sale.61 Although prompt payment is made for an arm’s-length transaction by the senior citizen, the real and compelling reason for the private establishment giving the discount is that the law itself makes it mandatory.

What RA 7432 grants the senior citizen is a mere discount privilege, not a sales discount or any of the above discounts in particular. Prompt payment is not the reason for (although a necessary consequence of) such grant. To be sure, the privilege enjoyed by the senior citizen must be equivalent to the tax credit benefit enjoyed by the private establishment granting the discount. Yet, under the revenue regulations promulgated by our tax authorities, this benefit has been erroneously likened and confined to a sales discount.

To a senior citizen, the monetary effect of the privilege may be the same as that resulting from a sales discount. However, to a private establishment, the effect is different from a simple reduction in price that results from such discount. In other words, the tax credit benefit is not the same as a sales discount. To repeat from our earlier discourse, this benefit cannot and should not be treated as a tax deduction.

To stress, the effect of a sales discount on the income statement and income tax return of an establishment covered by RA 7432 is different from that resulting from the availment or use of its tax credit benefit. While the former is a deduction before, the latter is a deduction after, the income tax is computed. As mentioned earlier, a discount is not necessarily a sales discount, and a tax credit for a simple discount privilege should not be automatically treated like a sales discount. Ubi lex non distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish.

Sections 2.i and 4 of Revenue Regulations No. (RR) 2-94 define tax credit as the 20 percent discount deductible from gross income for income tax purposes, or from gross sales for VAT or other percentage tax purposes. In effect, the tax credit benefit under RA 7432 is related to a sales discount. This contrived definition is improper, considering that the latter has to be deducted from gross sales in order to compute the gross income in theincome statement and cannot be deducted again, even for purposes of computing the income tax.

When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed -- shall be treated as a reduction from any tax liability, plain and simple. The option to avail of the tax credit benefit depends upon the existence of a tax liability, but to limit the benefit to a sales discount -- which is not even identical to the discount privilege that is granted by law -- does not define it at all and serves no useful purpose. The definition must, therefore, be stricken down.

Laws Not Amended

by Regulations

Second, the law cannot be amended by a mere regulation. In fact, a regulation that "operates to create a rule out of harmony with the statute is a mere nullity";62 it cannot prevail.

It is a cardinal rule that courts "will and should respect the contemporaneous construction placed upon a statute by the executive officers whose duty it is to enforce it x x x."63 In the scheme of judicial tax administration, the need for certainty and predictability in the implementation of tax laws is crucial.64 Our tax authorities fill in the details that "Congress may not have the opportunity or competence to provide."65 The regulations these authorities issue are relied upon by taxpayers, who are certain that these will be followed by the courts.66 Courts, however, will not uphold these authorities’ interpretations when clearly absurd, erroneous or improper.

In the present case, the tax authorities have given the term tax credit in Sections 2.i and 4 of RR 2-94 a meaning utterly in contrast to what RA 7432 provides. Their interpretation has muddled up the intent of Congress in granting a mere discount privilege, not a sales discount. The administrative agency issuing these regulations may not enlarge, alter or restrict the provisions of the law it administers; it cannot engraft additional requirements not contemplated by the legislature.67

In case of conflict, the law must prevail.68 A "regulation adopted pursuant to law is law."69 Conversely, a regulation or any portion thereof not adopted pursuant to law is no law and has neither the force nor the effect of law.70

Availment of Tax

Credit Voluntary

Third, the word may in the text of the statute71 implies that the availability of the tax credit benefit is neither unrestricted nor mandatory.72 There is no absolute right conferred upon respondent, or any similar taxpayer, to avail itself of the tax credit remedy whenever it chooses; "neither does it impose a duty on the part of the government to sit back and allow an important facet of tax collection to be at the sole control and discretion of the taxpayer."73 For the tax authorities to compel respondent to deduct the 20 percent discount from either its gross income or its gross sales74 is, therefore, not only to make an imposition without basis in law, but also to blatantly contravene the law itself.

What Section 4.a of RA 7432 means is that the tax credit benefit is merely permissive, not imperative. Respondent is given two options -- either to claim or not to claim the cost of the discounts as a tax credit. In fact, it may even ignore the credit and simply consider the gesture as an act of beneficence, an expression of its social conscience.

Granting that there is a tax liability and respondent claims such cost as a tax credit, then the tax credit can easily be applied. If there is none, the credit cannot be used and will just have to be carried over and revalidated75accordingly. If, however, the business continues to operate at a loss and no other taxes are due, thus compelling it to close shop, the credit can never be applied and will be lost altogether.

In other words, it is the existence or the lack of a tax liability that determines whether the cost of the discounts can be used as a tax credit. RA 7432 does not give respondent the unfettered right to avail itself of the credit whenever it pleases. Neither does it allow our tax administrators to expand or contract the legislative mandate. "The ‘plain meaning rule’ or verba legis in statutory construction is thus applicable x x x. Where the words of a statute are clear, plain and free from ambiguity, it must be given its literal meaning and applied without attempted interpretation."76

Tax Credit Benefit

Deemed   Just Compensation

Fourth, Sections 2.i and 4 of RR 2-94 deny the exercise by the State of its power of eminent domain. Be it stressed that the privilege enjoyed by senior citizens does not come directly from the State, but rather from the private establishments concerned. Accordingly, the tax credit benefit granted to these establishments can be deemed as their just compensation for private property taken by the State for public use.77

The concept of public use is no longer confined to the traditional notion of use by the public, but held synonymous with public interest, public benefit, public welfare, and public convenience.78 The discount privilege to which our senior citizens are entitled is actually a benefit enjoyed by the general public to which these citizens belong. The discounts given would have entered the coffers and formed part of the gross sales of the private establishments concerned, were it not for RA 7432. The

permanent reduction in their total revenues is a forced subsidy corresponding to the taking of private property for public use or benefit.

As a result of the 20 percent discount imposed by RA 7432, respondent becomes entitled to a just compensation. This term refers not only to the issuance of a tax credit certificate indicating the correct amount of the discounts given, but also to the promptness in its release. Equivalent to the payment of property taken by the State, such issuance -- when not done within a reasonable time from the grant of the discounts -- cannot be considered asjust compensation. In effect, respondent is made to suffer the consequences of being immediately deprived of its revenues while awaiting actual receipt, through the certificate, of the equivalent amount it needs to cope with the reduction in its revenues.79

Besides, the taxation power can also be used as an implement for the exercise of the power of eminent domain.80 Tax measures are but "enforced contributions exacted on pain of penal sanctions"81 and "clearly imposed for a public purpose."82 In recent years, the power to tax has indeed become a most effective tool to realize social justice, public welfare, and the equitable distribution of wealth.83

While it is a declared commitment under Section 1 of RA 7432, social justice "cannot be invoked to trample on the rights of property owners who under our Constitution and laws are also entitled to protection. The social justice consecrated in our [C]onstitution [is] not intended to take away rights from a person and give them to another who is not entitled thereto."84 For this reason, a just compensation for income that is taken away from respondent becomes necessary. It is in the tax credit that our legislators find support to realize social justice, and no administrative body can alter that fact.

To put it differently, a private establishment that merely breaks even85 -- without the discounts yet -- will surely start to incur losses because of such discounts. The same effect is expected if its mark-up is less than 20 percent, and if all its sales come from retail purchases by senior citizens. Aside from the observation we have already raised earlier, it will also be grossly unfair to an establishment if the discounts will be treated merely as deductions from either its gross income or its gross sales. Operating at a loss through no fault of its own, it will realize that thetax credit limitation under RR 2-94 is inutile, if not improper. Worse, profit-generating businesses will be put in a better position if they avail themselves of tax credits denied those that are losing, because no taxes are due from the latter.

Grant of   Tax Credit

Intended by the Legislature

Fifth, RA 7432 itself seeks to adopt measures whereby senior citizens are assisted by the community as a whole and to establish a program beneficial to them.86 These objectives are consonant with the constitutional policy of making "health x x x services available to all the people at affordable cost"87 and of giving "priority for the needs of the x x x elderly."88 Sections 2.i and 4 of RR 2-94, however, contradict these constitutional policies and statutory objectives.

Furthermore, Congress has allowed all private establishments a simple tax credit, not a deduction. In fact, no cash outlay is required from the government for the availment or use of such credit. The deliberations on February 5, 1992 of the Bicameral Conference Committee Meeting on Social Justice, which finalized RA 7432, disclose the true intent of our legislators to treat the sales discounts as a tax credit, rather than as a deduction from gross income. We quote from those deliberations as follows:

"THE CHAIRMAN (Rep. Unico). By the way, before that ano, about deductions from taxable income. I think we incorporated there a provision na - on the responsibility of the private hospitals and drugstores, hindi ba?

SEN. ANGARA. Oo.

THE CHAIRMAN. (Rep. Unico), So, I think we have to put in also a provision here about the deductions from taxable income of that private hospitals, di ba ganon 'yan?

MS. ADVENTO. Kaya lang po sir, and mga discounts po nila affecting government and public institutions, so, puwede na po nating hindi isama yung mga less deductions ng taxable income.

THE CHAIRMAN. (Rep. Unico). Puwede na. Yung about the private hospitals. Yung isiningit natin?

MS. ADVENTO. Singit na po ba yung 15% on credit. (inaudible/did not use the microphone).

SEN. ANGARA. Hindi pa, hindi pa.

THE CHAIRMAN. (Rep. Unico) Ah, 'di pa ba naisama natin?

SEN. ANGARA. Oo. You want to insert that?

THE CHAIRMAN (Rep. Unico). Yung ang proposal ni Senator Shahani, e.

SEN. ANGARA. In the case of private hospitals they got the grant of 15% discount, provided that, the private hospitals can claim the expense as a tax credit.

REP. AQUINO. Yah could be allowed as deductions in the perpetrations of (inaudible) income.

SEN. ANGARA. I-tax credit na lang natin para walang cash-out ano?

REP. AQUINO. Oo, tax credit. Tama, Okay. Hospitals ba o lahat ng establishments na covered.

THE CHAIRMAN. (Rep. Unico). Sa kuwan lang yon, as private hospitals lang.

REP. AQUINO. Ano ba yung establishments na covered?

SEN. ANGARA. Restaurant lodging houses, recreation centers.

REP. AQUINO. All establishments covered siguro?

SEN. ANGARA. From all establishments. Alisin na natin 'Yung kuwan kung ganon. Can we go back to Section 4 ha?

REP. AQUINO. Oho.

SEN. ANGARA. Letter A. To capture that thought, we'll say the grant of 20% discount from all establishments et cetera, et cetera, provided that said establishments - provided that private establishments may claim the cost as a tax credit. Ganon ba 'yon?

REP. AQUINO. Yah.

SEN. ANGARA. Dahil kung government, they don't need to claim it.

THE CHAIRMAN. (Rep. Unico). Tax credit.

SEN. ANGARA. As a tax credit [rather] than a kuwan - deduction, Okay.

REP. AQUINO Okay.

SEN. ANGARA. Sige Okay. Di subject to style na lang sa Letter A".89

Special Law

Over General Law

Sixth and last, RA 7432 is a special law that should prevail over the Tax Code -- a general law. "x x x [T]he rule is that on a specific matter the special law shall prevail over the general law, which shall be resorted to only to supply deficiencies in the former."90 In addition, "[w]here there are two statutes, the earlier special and the later general -- the terms of the general broad enough to include the matter provided for in the special -- the fact that one is special and the other is general creates a presumption that the special is to be considered as remaining an exception to the general,91 one as a general law of the land, the other as the law of a particular case."92 "It is a canon of statutory construction that a later statute, general in its terms and not expressly repealing a prior special statute, will ordinarily not affect the special provisions of such earlier statute."93

RA 7432 is an earlier law not expressly repealed by, and therefore remains an exception to, the Tax Code -- a later law. When the former states that a tax credit may be claimed, then the requirement of prior tax payments under certain provisions of the latter, as discussed above, cannot be made to apply. Neither can the instances of or references to a tax deduction under the Tax Code94 be made to restrict RA 7432. No provision of any revenue regulation can supplant or modify the acts of Congress.

WHEREFORE, the Petition is hereby DENIED. The assailed Decision and Resolution of the Court of Appeals AFFIRMED. No pronouncement as to costs.

SO ORDERED.

G.R. No. 148512             June 26, 2006

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.CENTRAL LUZON DRUG CORPORATION, Respondent.

D E C I S I O N

AZCUNA, J.:

This is a petition for review under Rule 45 of the Rules of Court seeking the nullification of the Decision, dated May 31, 2001, of the Court of Appeals (CA) in CA-G.R. SP No. 60057, entitled "Central Luzon Drug Corporation v. Commissioner of Internal Revenue," granting herein respondent Central Luzon Drug Corporation’s claim for tax credit equal to the amount of the 20% discount that it extended to senior citizens on the latter’s purchase of medicines pursuant to Section 4(a) of Republic Act (R.A.) No. 7432, entitled "An Act to Maximize the Contribution of Senior Citizens to Nation Building, Grant Benefits and Special Privileges and for other Purposes" otherwise known as the Senior Citizens Act.

The antecedents are as follows:

Central Luzon Drug Corporation has been a retailer of medicines and other pharmaceutical products since December 19, 1994. In 1995, it opened three (3) drugstores as a franchisee under the business name and style of "Mercury Drug."

For the period January 1995 to December 1995, in conformity to the mandate of Sec. 4(a) of R.A. No. 7432, petitioner granted a 20% discount on the sale of medicines to qualified senior citizens amounting to P219,778.

Pursuant to Revenue Regulations No. 2-941 implementing R.A. No. 7432, which states that the discount given to senior citizens shall be deducted by the establishment from its gross sales for value-added tax and other percentage tax purposes, respondent deducted the total amount of P219,778 from its gross income for the taxable year 1995. For said taxable period, respondent reported a net loss of P20,963 in its corporate income tax return. As a consequence, respondent did not pay income tax for 1995.

Subsequently, on December 27, 1996, claiming that according to Sec. 4(a) of R.A. No. 7432, the amount ofP219,778 should be applied as a tax credit, respondent filed a claim for refund in the amount of P150,193, thus:

Net Sales P 37,014,807.00

Add: Cost of 20% Discount to Senior Citizens 219,778.00

Gross Sales P 37,234,585.00

Less: Cost of Sales

Merchandise Inventory, beg P 1,232,740.00

Purchases 41,145,138.00

Merchandise Inventory, end8,521,557.00 33,856,621.00

Gross Profit P 3,377,964.00

Miscellaneous Income 39,014.00

Total Income 3,416,978.00

Operating Expenses 3,199,230.00

Net Income Before Tax P 217,748.00

Income Tax (35%) 69,585.00

Less: Tax Credit

(Cost of 20% Discount to Senior Citizens) 219,778.00

Income Tax Payable (P 150,193.00)

Income Tax Actually Paid -0-

Tax Refundable/Overpaid Income Tax (P 150,193.00)

As shown above, the amount of P150,193 claimed as a refund represents the tax credit allegedly due to respondent under R.A. No. 7432. Since the Commissioner of Internal Revenue "was not able to decide the claim for refund on time,"2 respondent filed a Petition for Review with the Court of Tax Appeals (CTA) on March 18, 1998.

On April 24, 2000, the CTA dismissed the petition, declaring that even if the law treats the 20% sales discounts granted to senior citizens as a tax credit, the same cannot apply when there is no tax liability or the amount of the tax credit is greater than the tax due. In the latter case, the tax credit will only be to the extent of the tax liability.3Also, no refund can be granted as no tax was erroneously, illegally and actually collected based on the provisions of Section 230, now Section 229, of the Tax Code. Furthermore, the law does not state that a refund can be claimed by the private establishment concerned as an alternative to the tax credit.

Thus, respondent filed with the CA a Petition for Review on August 3, 2000.

On May 31, 2001, the CA rendered a Decision stating that Section 229 of the Tax Code does not apply in this case. It concluded that the 20% discount given to senior citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A. No. 7432 is considered just compensation and, as such, may be carried over to the next taxable period if there is no current tax liability. In view of this, the CA held:

WHEREFORE, the instant petition is hereby GRANTED and the decision of the CTA dated 24 April 2000 and its resolution dated 06 July 2000 are SET ASIDE. A new one is entered granting petitioner’s claim for tax credit in the amount of Php: 150,193.00. No costs.

SO ORDERED.4

Hence, this petition raising the sole issue of whether the 20% sales discount granted by respondent to qualified senior citizens pursuant to Sec. 4(a) of R.A. No. 7432 may be claimed as a tax credit or as a deduction from gross sales in accordance with Sec. 2(1) of Revenue Regulations No. 2-94.

Sec. 4(a) of R.A. No. 7432 provides:

Sec. 4. Privileges for the Senior citizens. – The senior citizens shall be entitled to the following:

(a) the grant of twenty percent (20%) discount from all establishments relative to utilization of transportations services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit.

The CA and the CTA correctly ruled that based on the plain wording of the law discounts given under R.A. No. 7432 should be treated as tax credits, not deductions from income.

It is a fundamental rule in statutory construction that the legislative intent must be determined from the language of the statute itself especially when the words and phrases therein are clear and unequivocal. The statute in such a case must be taken to mean exactly what it says.5 Its literal meaning should be followed;6 to depart from the meaning expressed by the words is to alter the statute.7

The above provision explicitly employed the word "tax credit." Nothing in the provision suggests for it to mean a "deduction" from gross sales. To construe it otherwise would be a departure from the clear mandate of the law.

Thus, the 20% discount required by the Act to be given to senior citizens is a tax credit, not a deduction from the gross sales of the establishment concerned. As a corollary to this, the definition of ‘tax credit’ found in Section 2(1) of Revenue Regulations No. 2-94 is erroneous as it refers to tax credit as the amount representing the 20% discount that "shall be deducted by the said establishment from their gross sales for value added tax and other percentage tax purposes." This definition is contrary to what our lawmakers had envisioned with regard to the treatment of the discount granted to senior citizens.

Accordingly, when the law says that the cost of the discount may be claimed as a tax credit, it means that the amount -- when claimed – shall be treated as a reduction from any tax liability.8 The law cannot be amended by a mere regulation. The administrative agencies issuing these regulations may not enlarge, alter or restrict the provisions of the law they administer.9 In fact, a regulation that "operates to create a rule out of harmony with the statute is a mere nullity."10

Finally, for purposes of clarity, Sec. 22911 of the Tax Code does not apply to cases that fall under Sec. 4 of R.A. No. 7432 because the former provision governs exclusively all kinds of refund or credit of internal revenue taxes that were erroneously or illegally imposed and collected pursuant to the Tax Code while the latter extends the tax credit benefit to the private establishments concerned even before tax payments have been made. The tax credit that is contemplated under the Act is a form of just compensation, not a remedy for taxes that were erroneously or illegally assessed and collected. In the same vein, prior payment of any tax liability is not a precondition before a taxable entity can benefit from the tax credit. The credit may be availed of upon payment of the tax due, if any. Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year.

It must also be stressed that unlike in Sec. 229 of the Tax Code wherein the remedy of refund is available to the taxpayer, Sec. 4 of the law speaks only of a tax credit, not a refund.

As earlier mentioned, the tax credit benefit granted to the establishments can be deemed as their just compensation for private property taken by the State for public use. The privilege enjoyed by the senior citizens does not come directly from the State, but rather from the private establishments concerned.12

WHEREFORE, the petition is DENIED. The Decision of the Court of Appeals in CA-G.R. SP No. 60057, dated May 31, 2001, is AFFIRMED.

No pronouncement as to costs.

SO ORDERED.

G.R. No. 142299             June 22, 2006

BICOLANDIA DRUG CORPORATION (FORMERLY ELMAS DRUG COPRORATION), Petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, Respondent.

D E C I S I O N

AZCUNA, J.:

This is a petition for review1 by Bicolandia Drug Corporation, formerly known as Elmas Drug Corporation, seeking the nullification of the Decision and Resolution of the Court of Appeals, dated

October 19, 1999 and February 18, 2000, respectively, in CA-G.R SP No. 49946 entitled "Commissioner of Internal Revenue v. Elmas Drug Corporation."

The controversy primarily involves the proper interpretation of the term "cost" in Section 4 of Republic Act (R.A.) No. 7432, otherwise known as "An Act to Maximize the Contribution of Senior Citizens to Nation Building, Grant Benefits and Special Privileges and for Other Purposes."

The facts2 of the case are as follows:

Petitioner Bicolandia Drug Corporation is a domestic corporation principally engaged in the retail of pharmaceutical products. Petitioner has a drugstore located in Naga City under the name and business style of "Mercury Drug."

Pursuant to the provisions of R.A. No. 7432, entitled "An Act to Maximize the Contribution of Senior Citizens to Nation Building, Grant Benefits and Special Privileges and for Other Purposes," also known as the "Senior Citizens Act," and Revenue Regulations No. 2-94, petitioner granted to qualified senior citizens a 20% sales discount on their purchase of medicines covering the period from July 19, 1993 to December 31, 1994.

When petitioner filed its corresponding corporate annual income tax returns for taxable years 1993 and 1994, it claimed as a deduction from its gross income the respective amounts of P80,330 and P515,000 representing the 20% sales discount it granted to senior citizens.

On March 28, 1995, however, alleging error in the computation and claiming that the aforementioned 20% sales discount should have been treated as a tax credit pursuant to R.A. No. 7432 instead of a deduction from gross income, petitioner filed a claim for refund or credit of overpaid income tax for 1993 and 1994, amounting toP52,215 and P334,750, respectively. Petitioner computed the overpayment as follows:

Income tax benefit of tax credit 100%

Income tax benefit of tax deduction 35%

Differential 65%

For 1993

20% discount granted in 1993 P80,330

Multiply by 65% x 65%

Overpaid corporate income tax P52,215

For 1994

20% discount granted in 1993 P515,000

Multiply by 65% x 65%

Overpaid corporate income tax P334,750

On December 29, 1995, petitioner filed a Petition for Review with the Court of Tax Appeals (CTA) in order to toll the running of the two-year prescriptive period for claiming for a tax refund under Section 230, now Section 229, of the Tax Code.

It contended that Section 4 of R.A. No. 7432 provides in clear and unequivocal language that discounts granted to senior citizens may be claimed as a tax credit. Revenue Regulations No. 2-94, therefore, which is merely an implementing regulation cannot modify, alter or depart from the clear mandate of Section 4 of R.A. No. 7432, and, thus, is null and void for being inconsistent with the very statute it seeks to implement.

The Commissioner of Internal Revenue, on the other hand, maintained that the aforesaid section providing for a 20% sales discount to senior citizens is a misnomer as it runs counter to the solemn duty of the government to collect taxes. The Commissioner likewise pointed out that the provision in question employs the word "may," thereby implying that the availability of the remedy of tax credit is not absolute and mandatory and it does not confer an absolute right on the taxpayer to avail of the tax credit scheme if he so chooses. The Commissioner further stated that in statutory construction, the contemporaneous construction of a statute by executive officers of the government whose duty is to execute it is entitled to great respect and should ordinarily control in its interpretation.

Thus, addressing the matter of the proper construction of Section 4(a) of R.A. No. 7432 regarding the treatment of the 20% sales discount given to senior citizens on their medicine purchases, the CTA ruled on the issue of whether or not the discount should be deductible from gross sales of value-added tax or other percentage tax purposes as prescribed under Revenue Regulations No. 2-94 or as a tax credit deductible from the tax due.

In its Decision, dated August 27, 1998, the CTA declared that:

"x x x

Revenue Regulations No. 2-94 gave a new meaning to the phrase "tax credit," interpreting it to mean that the 20% discount granted to qualified senior citizens is an amount deductible from the establishment’s gross sales,which is completely contradictory to the literal or widely accepted meaning of the said phrase, as an amount subtracted from an individual’s or entity’s tax liability to arrive at the total tax liability (Black’s Law Dictionary).

In view of such apparent discrepancy in the interpretation of the term "tax credit", the provisions of the law under R.A. 7432 should prevail over the subordinate regulation issued by the respondent under Revenue Regulation No. 2-94. x x x

Having settled the legal issue involved in the case at bar, We are now tasked to resolve the factual issues of whether or not petitioner is entitled to the claim for refund of its overpaid income taxes for the years 1993 and 1994 based on the evidence at hand.

Contrary to the findings of the independent CPA, aside from the unverifiable 20% sales discounts in the amount ofP18,653.70 (Exh. R-3), the Court noted some material discrepancies. Not all the details listed in the 1994 "Summary of Sales and Discounts Given to Senior Citizens" correspond with the cash slips presented. There are various sales discounts granted which were not properly computed and there were also some cash slips left unsigned by the buyers.

x x x

After a careful scrutiny of the documents presented, the Court, allows only the amount of sales discounts duly supported by the pre-marked cash slips x x x.

Hence, only the above amounts which are properly documented can be used as base in computing for the cost of 20% discount as tax credit. The overpaid income tax therefore is computed as follows: 3

For 1993

Net Sales P31,080,508.00

Add: 20% Discount to Senior Citizens 80,330.00

Gross Sales P31,160,838.00

Less: Cost of Sales

Merchandise Inventory, beg. P 4,226,588.00

Add Purchases 29,234,361.00

Total Goods available for Sale P33,460,947.00

Less: Merchandise Inventory, End P 4,875.944.00 P28,585,003.00

Gross Income P 2,575,835.00

Less: Operating Expenses 1,706,491.00

Net Operating Income P 869,344.00

Add: Miscellaneous Income 72,680.00

Net Income P 942,024.00

Less: Interest Income Subject to Final Tax 21,140.00

Net Taxable Income P 920,884.00

Tax Due (P920,884 x 35%) P 322,309.40

Less: 1) Tax Credit (Cost of 20% Discount) [(28,585,003.00/31,160,838.00) x 80,330.34] P 73,690.03

2) Income Tax Payment for the Year 294,194.00 P 367,884.03

AMOUNT REFUNDABLEP 45,574.63

For 1994

Net Sales P 29,904,734.00

Add: 20% Discount to Senior Citizens 515,000.00

Gross Sales P 30,419,734.00

Less: Cost of Sales

Merchandise Inventory, beg. P 4,875,944.00

Add Purchases 28,138,103.00

Total Goods available for Sales P 33,014,047.00

Less: Merchandise Inventory, End 5,036.117.00 27,977,930.00

Gross Income P 2,441,804.00

Less: Operating Expenses 1,880,153.00

Net Operating Income P 561,651.00

Add: Miscellaneous Income 82,207.00

Net Income P 643,858.00

Less: Interest Income Subject to Final Tax 30,618.00

Net Taxable Income P 613,240.00

Tax Due (613,240 x 35%) P 214,634.00

Less: 1) Tax Credit (Cost of 20% Discount) [(28,585,003.00/31,160,838.00) x 80,330.34] P316,156.48

2) Income Tax Payment for the Year 34,384.00 P 350,540.48

AMOUNT REFUNDABLE P 135,906.48

WHEREFORE, in view of all the foregoing, petitioner’s claim for refund is hereby partially GRANTED. Respondent is hereby ORDERED to REFUND, or in the alternative, to ISSUE a tax credit certificate in favor of the petitioner the amounts of P45,574.63 and P135,906.48, representing overpaid income tax for the years 1993 and 1994, respectively.

SO ORDERED.4

Both the Commissioner and petitioner moved for a reconsideration of the above decision. Petitioner, in its Motion for Partial Reconsideration, claimed that the "cost" that private establishments may claim as tax credit under Section 4 of R.A. No. 7432 should be construed to mean the full amount of

the 20% sales discount granted to senior citizens instead of the formula --[Tax Credit = Cost of Sales/Gross Sales x 20% discount] – used by the CTA in computing for the amount of the tax credit. In view of this, petitioner prayed for the refund of the amount of income tax it allegedly overpaid in the aggregate amount of P45,574.63 and P135,906.48, respectively, for the taxable years 1993 and 1994 as a result of treating the sales discount of 20% as a tax deduction rather than as a tax credit.

The Commissioner, on the other hand, moved for a re-computation of petitioner’s tax liability averring that the sales discount of 20% should be deducted from gross income to arrive at the taxable income. Such discount cannot be considered a tax credit because the latter, being in the nature of a tax refund, is treated as a return of tax payments erroneously or excessively assessed and collected as provided under Section 204(3) of the Tax Code, to wit:

(3) x x x No credit or refund of taxes or penalties shall be allowed unless the taxpayer files in writing with the Commissioner a claim for credit or refund within two (2) years after the payment of the tax or penalty.

lawphil.net

In its Resolution, dated December 7, 1998, the CTA modified its earlier decision, thus:

ACCORDINGLY, the petitioner’s Motion for Partial Reconsideration is hereby GRANTED. Respondent is hereby ORDERED to ISSUE tax credit certificates in favor of petitioner [in] the amounts of P45,574.63 and P135,906.48 representing overpaid income tax for the years 1993 and 1994, as prayed for in its motion. On the other hand, the Respondent’s Motion for Reconsideration is DENIED for lack of merit.

SO ORDERED.5

Consequently, the Commissioner filed a petition for review with the Court of Appeals asking for the reversal of the CTA Decision and Resolution.

The Court of Appeals rendered its assailed Decision on October 19, 1999, the dispositive portion of which reads:

WHEREFORE, in view of the foregoing premises, the petition is hereby GRANTED IN PART. The resolution issued by the Court of Tax Appeals dated December [7], 1998 is SET ASIDE and the Decision rendered by the latter is AFFIRMED IN TOTO.

No costs.

SO ORDERED.6

Hence, this petition positing that:

THE COURT OF APPEALS ERRED IN RULING THAT IN COMPUTING THE TAX CREDIT TO BE ALLOWED PETITIONER FOR DISCOUNTS GRANTED TO SENIOR CITIZENS ON THEIR PURCHASE OF MEDICINES, THE ACQUISITION COST RATHER THAN THE ACTUAL DISCOUNT GRANTED TO SENIOR CITIZENS SHOULD BE THE BASIS.7

Otherwise stated, the matter to be determined is the amount of tax credit that may be claimed by a taxable entity which grants a 20% sales discount to qualified senior citizens on their purchase of medicines pursuant to Section 4(a) of R.A. No. 7432 which states:

Sec. 4. Privileges for the Senior citizens. – The senior citizens shall be entitled to the following:

a) the grant of twenty percent (20%) discount from all establishments relative to utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost8 as tax credit.

The term "cost" in the above provision refers to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines. This amount shall be applied as a tax credit, and may be deducted from the tax liability of the entity concerned. If there is no current tax due or the establishment reports a net loss for the period, the credit may be carried over to the succeeding taxable year. This is in line with the interpretation of this Court in Commissioner of Internal Revenue v. Central Luzon Drug Corporation9 wherein it affirmed that R.A. No. 7432 allows private establishments to claim as tax credit the amount of discounts they grant to senior citizens.

The Court notes that petitioner, while praying for the reinstatement of the CTA Resolution, dated December 7, 1998, directing the issuance of tax certificates in favor of petitioner for the respective amounts of P45,574.63 andP135,906.48 representing overpaid income tax for 1993 and 1994, asks for the refund of the same.10

In this regard, petitioner’s claim for refund must be denied. The law expressly provides that the discount given to senior citizens may be claimed as a tax credit, and not a refund. Thus, where the words of a statute are clear, plain and free from ambiguity, it must be given its literal meaning and applied without attempted interpretation.11

WHEREFORE, the petition is PARTLY GRANTED. The Decision and Resolution of the Court of Appeals, dated October 19, 1999 and February 18, 2000, respectively, in CA-G.R SP No. 49946 are REVERSED and SET ASIDE. The Resolution of the Court of Tax Appeals, dated December 7, 1998, directing the issuance of tax credit certificates in favor of petitioner in the amounts of P45,574.63 and P135,906.48 is hereby REINSTATED. No costs.

SO ORDERED.

G.R. No. 159610             June 12, 2008

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.CENTRAL LUZON DRUG CORPORATION, respondent.

D E C I S I O N

CARPIO, J.:

The Case

This petition for review on certiorari assails the 13 August 2003 Decision of the Court of Appeals in CA-G.R. SP No. 70480. The Court of Appeals dismissed the appeal filed by the Commissioner of Internal Revenue (petitioner) questioning the 15 April 2002 Decision of the Court of Tax Appeals (CTA) in CTA Case No. 6054 ordering petitioner to issue, in favor of Central Luzon Drug Corporation (respondent), a tax credit certificate in the amount of P2,376,805.63, arising from the alleged erroneous interpretation of the term "tax credit" used in Section 4(a) of Republic Act No. (RA) 7432.

The Facts

Respondent is a domestic corporation engaged in the retail of medicines and other pharmaceutical products.5 In 1997, it operated eight drugstores under the business name and style "Mercury Drug."

Pursuant to the provisions of RA 7432 and Revenue Regulations No. (RR) 2-94 issued by the Bureau of Internal Revenue (BIR), respondent granted 20% sales discount to qualified senior citizens on their purchases of medicines covering the calendar year 1997. The sales discount granted to senior citizens totaled P2,798,508.00.

On 15 April 1998, respondent filed its 1997 Corporate Annual Income Tax Return reflecting a nil income tax liability due to net loss incurred from business operations of P2,405,140.00. Respondent filed its 1997 Income Tax Return under protest.

On 19 March 1999, respondent filed with the petitioner a claim for refund or credit of overpaid income tax for the taxable year 1997 in the amount of P2,660,829.00 Respondent alleged that the overpaid tax was the result of the wrongful implementation of RA 7432. Respondent treated the 20% sales discount as a deduction from gross sales in compliance with RR 2-94 instead of treating it as a tax credit as provided under Section 4(a) of RA 7432.

On 6 April 2000, respondent filed a Petition for Review with the CTA in order to toll the running of the two-year statutory period within which to file a judicial claim. Respondent reasoned that RR 2-94, which is a mere implementing administrative regulation, cannot modify, alter or amend the clear mandate of RA 7432. Consequently, Section 2(i) of RR 2-94 is without force and effect for being inconsistent with the law it seeks to implement.

In his Answer, petitioner stated that the construction given to a statute by a specialized administrative agency like the BIR is entitled to great respect and should be accorded great weight. When RA 7432 allowed senior citizens' discounts to be claimed as tax credit, it was silent as to the mechanics of availing the same. For clarification, the BIR issued RR 2-94 and defined the term "tax credit" as a deduction from the establishment's gross income and not from its tax liability in order to avoid an absurdity that is not intended by the law. 

The Ruling of the Court of Tax Appeals

On 15 April 2002, the CTA rendered a Decision ordering petitioner to issue a tax credit certificate in the amount ofP2,376,805.63 in favor of respondent.

The CTA stated that in a number of analogous cases, it has consistently ruled that the 20% senior citizens' discount should be treated as tax credit instead of a mere deduction from gross income. In quoting its previous decisions, the CTA ruled that RR 2-94 engraved a new meaning to the phrase "tax credit" as deductible from gross income which is a deviation from the plain intendment of the law. An administrative regulation must not contravene but should conform to the standards that the law prescribes.

The CTA also ruled that respondent has properly substantiated its claim for tax credit by documentary evidence. However, based on the examination conducted by the commissioned independent certified public accountant (CPA), there were some material discrepancies due to missing cash slips, lack of senior citizen's ID number, failure to include the cash slips in the summary report and vice versa. Therefore, between the Summary Report presented by respondent and the audited amount presented by the independent CPA, the CTA deemed it proper to consider the lesser of two amounts.

The re-computation of the overpaid income tax for the year 1997 is as follows:

Sales, Net P176,742,607.00

Add: 20% Sales Discount to Senior Citizens 2,798,508.00

Sales, Gross P179,541,115.00

Less: Cost of Sales

Merchandise inventory, beg. P 20,905,489.00

Purchases 168,762,950.00

Merchandise inventory, end -27,281,439.00 162,387,000.00

Gross Profit P 17,154,115.00

Add: Miscellaneous income 402,124.00

Total Income P 17,556,239.00

Less: Operating expenses 16,913,699.00

Net Income P 642,540.00

Less: Income subjected to final tax (Interest Income16) 249,172.00

Net Taxable Income P 393,368.00

Income Tax Due (35%) P 137,679.00

Less: Tax Credit (Cost of 20% discount as adjusted17) 2,514,484.63

Income Tax Payable (P 2,376,805.63)

Income Tax Actually Paid             0.00

Income Tax Refundable (P 2,376,805.63)

Aggrieved by the CTA's decision, petitioner elevated the case before the Court of Appeals.

The Ruling of the Appellate Court

On 13 August 2003, the Court of Appeals affirmed the CTA's decision in toto.

The Court of Appeals disagreed with petitioner's contention that the CTA's decision applied a literal interpretation of the law. It reasoned that under the verba legis rule, if the statute is clear, plain, and free from ambiguity, it must be given its literal meaning and applied without interpretation. This principle rests on the presumption that the words used by the legislature in a statute correctly express its intent and preclude the court from construing it differently.

The Court of Appeals distinguished "tax credit" as an amount subtracted from a taxpayer's total tax liability to arrive at the tax due while a "tax deduction" reduces the taxpayer's taxable income upon which the tax liability is computed. "A credit differs from deduction in that the former is subtracted from tax while the latter is subtracted from income before the tax is computed."

The Court of Appeals found no legal basis to support petitioner's opinion that actual payment by the taxpayer or actual receipt by the government of the tax sought to be credited or refunded is a condition sine qua non for the availment of tax credit as enunciated in Section 229 of the Tax Code. The Court of Appeals stressed that Section 229 of the Tax Code pertains to illegally collected or erroneously paid taxes while RA 7432 is a special law which uses the method of tax credit in the context of just compensation. Further, RA 7432 does not require prior tax payment as a condition for claiming the cost of the sales discount as tax credit.

Hence, this petition.

The Issues

Petitioner raises two issues in this Petition:

1. Whether the appellate court erred in holding that respondent may claim the 20% senior citizens' sales discount as a tax credit deductible from future income tax liabilities instead of a mere deduction from gross income or gross sales; and

2. Whether the appellate court erred in holding that respondent is entitled to a refund.

The Ruling of the Court

The petition lacks merit.

The issues presented are not novel. In two similar cases involving the same parties where respondent lodged its claim for tax credit on the senior citizens' discount granted in 199522 and 1996,23 this Court has squarely ruled that the 20% senior citizens' discount required by RA 7432 may be claimed as a tax credit and not merely a tax deduction from gross sales or gross income. Under RA 7432, Congress granted the tax credit benefit to all covered establishments without conditions. The net loss incurred in a taxable year does not preclude the grant of tax credit because by its nature, the tax credit may still be deducted from a future, not a present, tax liability. However, the senior citizens' discount granted as a tax credit cannot be refunded.

RA 7432 expressly allows private establishmentsto claim the amount of discounts they grant to senior citizens

as tax credit.

Section 4(a) of RA 7432 states:

SECTION 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following:

a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of medicines anywhere in the country: Provided, That private establishments may claim the cost as tax credit; (Emphasis supplied)

However, RR 2-94 interpreted the tax credit provision of RA 7432 in this wise:

Sec. 2. DEFINITIONS. - For purposes of these regulations:

x x x

i. Tax Credit - refers to the amount representing 20% discount granted to a qualified senior citizen by all establishments relative to their utilization of transportation services, hotels and similar lodging establishments, restaurants, drugstores, recreation centers, theaters, cinema houses, concert halls, circuses, carnivals and other similar places of culture, leisure and amusement, which discount shall be deducted by the said establishments from their gross income for income tax purposes and from their gross sales for value-added tax or other percentage tax purposes. (Emphasis supplied).

x x x

Sec. 4. Recording/Bookkeeping Requirement for Private Establishments

x x x

The amount of 20% discount shall be deducted from the gross income for income tax purposesand from gross sales of the business enterprise concerned for purposes of the VAT and other percentage taxes. (Emphasis supplied)

Tax credit is defined as a peso-for-peso reduction from a taxpayer's tax liability. It is a direct subtraction from the tax payable to the government. On the other hand, RR 2-94 treated the amount of senior citizens' discount as a tax deduction which is only a subtraction from gross income resulting to a lower taxable income. RR 2-94 treats the senior citizens' discount in the same manner as the allowable deductions provided in Section 34, Chapter VII of the National Internal Revenue Code. RR 2-94 affords merely a fractional reduction in the taxes payable to the government depending on the applicable tax rate.

In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court ruled that petitioner's definition in RR 2-94 of a tax credit is clearly erroneous. To deny the tax credit, despite the plain mandate of the law, is indefensible. In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court declared,"When the law says that the cost of the discount may be claimed as a tax credit, it means that the amount- when claimed ― shall be treated as a reduction from any tax liability, plain and simple." The Court further stated that the law cannot be amended by a mere regulation because "administrative agencies in issuing these regulations may not enlarge, alter or restrict the provisions of the law it administers; it cannot engraft additional requirements not contemplated by the legislature." Hence, there being a dichotomy in the law and the revenue regulation, the definition provided in Section 2(i) of RR 2-94 cannot be given effect.

The tax credit may still be deductedfrom a future, not a present, tax liability.

In the petition filed before this Court, petitioner alleged that respondent incurred a net loss from its business operations in 1997; hence, it did not pay any income tax. Since no tax payment was made, it follows that no tax credit can also be claimed because tax credits are usually applied against a tax liability.

In Commissioner of Internal Revenue v. Central Luzon Drug Corporation, the Court stressed that prior payment of tax liability is not a pre-condition before a taxable entity can avail of the tax credit. The Court declared, "Where there is no tax liability or where a private establishment reports a net loss for the period, the tax credit can be availed of and carried over to the next taxable year."27 It is irrefutable that under RA 7432, Congress has granted the tax credit benefit to all covered establishments without conditions. Therefore, neither a tax liability nor a prior tax payment is required for the existence or grant of a tax credit.28 The applicable law on this point is clear and without any qualifications.

Hence, respondent is entitled to claim the amount of P2,376,805.63 as tax credit despite incurring net loss from business operations for the taxable year 1997.

The senior citizens' discount may be claimedas a tax credit and not a refund.

Section 4(a) of RA 7432 expressly provides that private establishments may claim the cost as a tax credit. A tax credit can only be utilized as payment for future internal revenue tax liabilities of the taxpayer while a tax refund, issued as a check or a warrant, can be encashed. A tax refund can be

availed of immediately while a tax credit can only be utilized if the taxpayer has existing or future tax liabilities.

If the words of the law are clear, plain, and free of ambiguity, it must be given its literal meaning and applied without any interpretation. Hence, the senior citizens' discount may be claimed as a tax credit and not as a refund.

RA 9257 now specifically provides that all covered establishmentsmay claim the senior citizens' discount as tax deduction.

On 26 February 2004, RA 9257, otherwise known as the "Expanded Senior Citizens Act of 2003," was signed into law and became effective on 21 March 2004.

RA 9257 has amended RA 7432. Section 4(a) of RA 9257 reads:

"Sec. 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following:

(a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of services in hotels and similar lodging establishments, restaurants and recreation centers, and purchase of medicines in all establishments for the exclusive use or enjoyment of senior citizens, including funeral and burial services for the death of senior citizens;

x x x

The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted. Provided,further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended." (Emphasis supplied)

Contrary to the provision in RA 7432 where the senior citizens' discount granted by all covered establishments can be claimed as tax credit, RA 9257 now specifically provides that this discount should be treated as tax deduction.

With the effectivity of RA 9257 on 21 March 2004, there is now a new tax treatment for senior citizens' discount granted by all covered establishments. This discount should be considered as a deductible expense from gross income and no longer as tax credit. The present case, however, covers the taxable year 1997 and is thus governed by the old law, RA 7432.

WHEREFORE, we DENY the petition. We AFFIRM the assailed Decision of the Court of Appeals dated 13 August 2003 in CA-G.R. SP No. 70480.

No pronouncement as to costs.

SO ORDERED

EN BANC

G.R. No. 166494              June 29, 2007

CARLOS SUPERDRUG CORP., doing business under the name and style "Carlos Superdrug," ELSIE M. CANO, doing business under the name and style "Advance Drug," Dr. SIMPLICIO L. YAP, JR., doing business under the name and style "City Pharmacy," MELVIN S. DELA SERNA, doing business under the name and style "Botica dela Serna," and LEYTE SERV-WELL CORP., doing business under the name and style "Leyte Serv-Well Drugstore," petitioners, vs.DEPARTMENT OF SOCIAL WELFARE and DEVELOPMENT (DSWD), DEPARTMENT OF HEALTH (DOH), DEPARTMENT OF FINANCE (DOF), DEPARTMENT OF JUSTICE (DOJ), and DEPARTMENT OF INTERIOR and LOCAL GOVERNMENT (DILG), respondents.

D E C I S I O N

AZCUNA, J.:

This is a petition for Prohibition with Prayer for Preliminary Injunction assailing the constitutionality of Section 4(a) of Republic Act (R.A.) No. 9257, otherwise known as the "Expanded Senior Citizens Act of 2003."

Petitioners are domestic corporations and proprietors operating drugstores in the Philippines.

Public respondents, on the other hand, include the Department of Social Welfare and Development (DSWD), the Department of Health (DOH), the Department of Finance (DOF), the Department of Justice (DOJ), and the Department of Interior and Local Government (DILG) which have been specifically tasked to monitor the drugstores’ compliance with the law; promulgate the implementing rules and regulations for the effective implementation of the law; and prosecute and revoke the licenses of erring drugstore establishments.

The antecedents are as follows:

On February 26, 2004, R.A. No. 9257, amending R.A. No. 7432, was signed into law by President Gloria Macapagal-Arroyo and it became effective on March 21, 2004. Section 4(a) of the Act states:

SEC. 4. Privileges for the Senior Citizens. – The senior citizens shall be entitled to the following:

(a) the grant of twenty percent (20%) discount from all establishments relative to the utilization of services in hotels and similar lodging establishments, restaurants and recreation centers, and purchase of medicines in all establishments for the exclusive use or enjoyment of senior citizens, including funeral and burial services for the death of senior citizens;

. . .

The establishment may claim the discounts granted under (a), (f), (g) and (h) as tax deduction based on the net cost of the goods sold or services rendered: Provided, That the cost of

the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted. Provided, further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as

amended.

On May 28, 2004, the DSWD approved and adopted the Implementing Rules and Regulations of R.A. No. 9257, Rule VI, Article 8 of which states:

Article 8. Tax Deduction of Establishments. – The establishment may claim the discounts granted under Rule V, Section 4 – Discounts for Establishments; Section 9, Medical and Dental Services in Private Facilities[,]6 and Sections 10 and 11 – Air, Sea and Land Transportation as tax deduction based on the net cost of the goods sold or services rendered. Provided, That the cost of the discount shall be allowed as deduction from gross income for the same taxable year that the discount is granted; Provided, further, That the total amount of the claimed tax deduction net of value added tax if applicable, shall be included in their gross sales receipts for tax purposes and shall be subject to proper documentation and to the provisions of the National Internal Revenue Code, as amended; Provided, finally, that the implementation of the tax deduction shall be subject to the Revenue Regulations to be issued by the Bureau of Internal Revenue (BIR) and approved by the Department of Finance (DOF).

On July 10, 2004, in reference to the query of the Drug Stores Association of the Philippines (DSAP) concerning the meaning of a tax deduction under the Expanded Senior Citizens Act, the DOF, through Director IV Ma. Lourdes B. Recente, clarified as follows:

1) The difference between the Tax Credit (under the Old Senior Citizens Act) and Tax Deduction (under the Expanded Senior Citizens Act).

1.1. The provision of Section 4 of R.A. No. 7432 (the old Senior Citizens Act) grants twenty percent (20%) discount from all establishments relative to the utilization of transportation services, hotels and similar lodging establishment, restaurants and recreation centers and purchase of medicines anywhere in the country, the costs of which may be claimed by the private establishments concerned as tax credit.

Effectively, a tax credit is a peso-for-peso deduction from a taxpayer’s tax liability due to the government of the amount of discounts such establishment has granted to a senior citizen. The establishment recovers the full amount of discount given to a senior citizen and hence, the government shoulders 100% of the discounts granted.

It must be noted, however, that conceptually, a tax credit scheme under the Philippine tax system, necessitates that prior payments of taxes have been made and the taxpayer is attempting to recover this tax payment from his/her income tax due. The tax credit scheme under R.A. No. 7432 is, therefore, inapplicable since no tax payments have previously occurred.

1.2. The provision under R.A. No. 9257, on the other hand, provides that the establishment concerned may claim the discounts under Section 4(a), (f), (g) and (h) as tax deduction from gross income, based on the net cost of goods sold or services rendered.

Under this scheme, the establishment concerned is allowed to deduct from gross income, in computing for its tax liability, the amount of discounts granted to senior citizens. Effectively, the government loses in terms of foregone revenues an amount equivalent to the marginal tax rate the said establishment is liable to pay the government. This will be an amount equivalent to 32% of the twenty percent (20%) discounts so granted. The establishment shoulders the remaining portion of the granted discounts.

It may be necessary to note that while the burden on [the] government is slightly diminished in terms of its percentage share on the discounts granted to senior citizens, the number of potential establishments that may claim tax deductions, have however, been broadened. Aside from the establishments that may claim tax credits under the old law, more establishments were added under the new law such as: establishments providing medical and dental services, diagnostic and laboratory services, including professional fees of attending doctors in all private hospitals and medical facilities, operators of domestic air and sea transport services, public railways and skyways and bus transport services.

A simple illustration might help amplify the points discussed above, as follows:

Tax Deduction Tax Credit

Gross Sales x x x x x x x x x x x x

Less : Cost of goods sold x x x x x x x x x x

Net Sales x x x x x x x x x x x x

Less: Operating Expenses:

Tax Deduction on Discounts x x x x --

Other deductions: x x x x x x x x

Net Taxable Income x x x x x x x x x x

Tax Due x x x x x x

Less: Tax Credit -- ______x x

Net Tax Due -- x x

As shown above, under a tax deduction scheme, the tax deduction on discounts was subtracted from Net Sales together with other deductions which are considered as operating expenses before the Tax Due was computed based on the Net Taxable Income. On the other hand, under a tax credit scheme, the amount of discounts which is the tax credit item, was deducted directly from the tax due amount.

Meanwhile, on October 1, 2004, Administrative Order (A.O.) No. 171 or the Policies and Guidelines to Implement the Relevant Provisions of Republic Act 9257, otherwise known as the "Expanded Senior Citizens Act of 2003"was issued by the DOH, providing the grant of twenty percent (20%) discount in the purchase of unbranded generic medicines from all establishments dispensing medicines for the exclusive use of the senior citizens.

On November 12, 2004, the DOH issued Administrative Order No 177 amending A.O. No. 171. Under A.O. No. 177, the twenty percent discount shall not be limited to the purchase of unbranded generic medicines only, but shall extend to both prescription and non-prescription medicines whether branded or generic. Thus, it stated that "[t]he grant of twenty percent (20%) discount shall be provided in the purchase of medicines from all establishments dispensing medicines for the exclusive use of the senior citizens."

Petitioners assail the constitutionality of Section 4(a) of the Expanded Senior Citizens Act based on the following grounds:

1) The law is confiscatory because it infringes Art. III, Sec. 9 of the Constitution which provides that private property shall not be taken for public use without just compensation;

2) It violates the equal protection clause (Art. III, Sec. 1) enshrined in our Constitution which states that "no person shall be deprived of life, liberty or property without due process of law, nor shall any person be denied of the equal protection of the laws;" and

3) The 20% discount on medicines violates the constitutional guarantee in Article XIII, Section 11 that makes "essential goods, health and other social services available to all people at affordable cost."

Petitioners assert that Section 4(a) of the law is unconstitutional because it constitutes deprivation of private property. Compelling drugstore owners and establishments to grant the discount will result in a loss of profit

and capital because 1) drugstores impose a mark-up of only 5% to 10% on branded medicines; and 2) the law failed to provide a scheme whereby drugstores will be justly compensated for the discount.

Examining petitioners’ arguments, it is apparent that what petitioners are ultimately questioning is the validity of the tax deduction scheme as a reimbursement mechanism for the twenty percent (20%) discount that they extend to senior citizens.

Based on the afore-stated DOF Opinion, the tax deduction scheme does not fully reimburse petitioners for the discount privilege accorded to senior citizens. This is because the discount is treated as a deduction, a tax-deductible expense that is subtracted from the gross income and results in a lower taxable income. Stated otherwise, it is an amount that is allowed by law to reduce the income prior to the application of the tax rate to compute the amount of tax which is due. Being a tax deduction, the discount does not reduce taxes owed on a peso for peso basis but merely offers a fractional reduction in taxes owed.

Theoretically, the treatment of the discount as a deduction reduces the net income of the private establishments concerned. The discounts given would have entered the coffers and formed part of the gross sales of the private establishments, were it not for R.A. No. 9257.

The permanent reduction in their total revenues is a forced subsidy corresponding to the taking of private property for public use or benefit. This constitutes compensable taking for which petitioners would ordinarily become entitled to a just compensation.

Just compensation is defined as the full and fair equivalent of the property taken from its owner by the expropriator. The measure is not the taker’s gain but the owner’s loss. The word just is used to intensify the meaning of the word compensation, and to convey the idea that the equivalent to be rendered for the property to be taken shall be real, substantial, full and ample.

A tax deduction does not offer full reimbursement of the senior citizen discount. As such, it would not meet the definition of just compensation.

Having said that, this raises the question of whether the State, in promoting the health and welfare of a special group of citizens, can impose upon private establishments the burden of partly subsidizing a government program.

The Court believes so.

The Senior Citizens Act was enacted primarily to maximize the contribution of senior citizens to nation-building, and to grant benefits and privileges to them for their improvement and well-being as the State considers them an integral part of our society.

The priority given to senior citizens finds its basis in the Constitution as set forth in the law itself. Thus, the Act provides:

SEC. 2. Republic Act No. 7432 is hereby amended to read as follows:

SECTION 1. Declaration of Policies and Objectives. – Pursuant to Article XV, Section 4 of the Constitution, it is the duty of the family to take care of its elderly members while the State may design programs of social security for them. In addition to this, Section 10 in the Declaration of Principles and State Policies provides: "The State shall provide social justice in all phases of national development." Further, Article XIII, Section 11, provides: "The State shall adopt an integrated and comprehensive approach to health development which shall endeavor to make essential goods, health and other social services available to all the people at affordable cost. There shall be priority for the needs of the underprivileged sick, elderly, disabled, women and children." Consonant with these constitutional principles the following are the declared policies of this Act:

. . .

(f) To recognize the important role of the private sector in the improvement of the welfare of senior citizens and to actively seek their partnership.

To implement the above policy, the law grants a twenty percent discount to senior citizens for medical and dental services, and diagnostic and laboratory fees; admission fees charged by theaters, concert halls, circuses, carnivals, and other similar places of culture, leisure and amusement; fares for domestic land, air and sea travel; utilization of services in hotels and similar lodging establishments, restaurants and recreation centers; and purchases of medicines for the exclusive use or enjoyment of senior citizens. As a form of reimbursement, the law provides that business establishments extending the twenty percent discount to senior citizens may claim the discount as a tax deduction.

The law is a legitimate exercise of police power which, similar to the power of eminent domain, has general welfare for its object. Police power is not capable of an exact definition, but has been purposely veiled in general terms to underscore its comprehensiveness to meet all exigencies and provide enough room for an efficient and flexible response to conditions and circumstances, thus assuring the greatest benefits.  Accordingly, it has been described as "the most essential, insistent and the least limitable of powers, extending as it does to all the great public needs." It is "[t]he power vested in the legislature by the constitution to make, ordain, and establish all manner of wholesome and reasonable laws, statutes, and ordinances, either with penalties or without, not repugnant to the constitution, as they shall judge to be for the good and welfare of the commonwealth, and of the subjects of the same."

For this reason, when the conditions so demand as determined by the legislature, property rights must bow to the primacy of police power because property rights, though sheltered by due process, must yield to general welfare.

Police power as an attribute to promote the common good would be diluted considerably if on the mere plea of petitioners that they will suffer loss of earnings and capital, the questioned provision is invalidated. Moreover, in the absence of evidence demonstrating the alleged confiscatory effect of the provision in question, there is no basis for its nullification in view of the presumption of validity which every law has in its favor.

Given these, it is incorrect for petitioners to insist that the grant of the senior citizen discount is unduly oppressive to their business, because petitioners have not taken time to calculate correctly and come up with a financial report, so that they have not been able to show properly whether or not the tax deduction scheme really works greatly to their disadvantage.

In treating the discount as a tax deduction, petitioners insist that they will incur losses because, referring to the DOF Opinion, for every P1.00 senior citizen discount that petitioners would give, P0.68 will be shouldered by them as only P0.32 will be refunded by the government by way of a tax deduction.

To illustrate this point, petitioner Carlos Super Drug cited the anti-hypertensive maintenance drug Norvasc as an example. According to the latter, it acquires Norvasc from the distributors at P37.57 per tablet, and retails it atP39.60 (or at a margin of 5%). If it grants a 20% discount to senior citizens or an amount equivalent to P7.92, then it would have to sell Norvasc at P31.68 which translates to a loss from capital of P5.89 per tablet. Even if the government will allow a tax deduction, only P2.53 per tablet will be refunded and not the full amount of the discount which is P7.92. In short, only 32% of the 20% discount will be reimbursed to the drugstores.

Petitioners’ computation is flawed. For purposes of reimbursement, the law states that the cost of the discount shall be deducted from gross income,29 the amount of income derived from all sources before deducting allowable expenses, which will result in net income. Here, petitioners tried to show a loss on a per transaction basis, which should not be the case. An income statement, showing an accounting of petitioners’ sales, expenses, and net profit (or loss) for a given period could have accurately reflected the effect of the discount on their income. Absent any financial statement, petitioners cannot substantiate their claim that they will be operating at a loss should they give the discount. In addition, the computation was erroneously based on the assumption that their customers consisted wholly of senior citizens. Lastly, the 32% tax rate is to be imposed on income, not on the amount of the discount.

Furthermore, it is unfair for petitioners to criticize the law because they cannot raise the prices of their medicines given the cutthroat nature of the players in the industry. It is a business decision on

the part of petitioners to peg the mark-up at 5%. Selling the medicines below acquisition cost, as alleged by petitioners, is merely a result of this decision. Inasmuch as pricing is a property right, petitioners cannot reproach the law for being oppressive, simply because they cannot afford to raise their prices for fear of losing their customers to competition.

The Court is not oblivious of the retail side of the pharmaceutical industry and the competitive pricing component of the business. While the Constitution protects property rights, petitioners must accept the realities of business and the State, in the exercise of police power, can intervene in the operations of a business which may result in an impairment of property rights in the process.

Moreover, the right to property has a social dimension. While Article XIII of the Constitution provides the precept for the protection of property, various laws and jurisprudence, particularly on agrarian reform and the regulation of contracts and public utilities, continuously serve as a reminder that the right to property can be relinquished upon the command of the State for the promotion of public good

Undeniably, the success of the senior citizens program rests largely on the support imparted by petitioners and the other private establishments concerned. This being the case, the means employed in invoking the active participation of the private sector, in order to achieve the purpose or objective of the law, is reasonably and directly related. Without sufficient proof that Section 4(a) of R.A. No. 9257 is arbitrary, and that the continued implementation of the same would be unconscionably detrimental to petitioners, the Court will refrain from quashing a legislative act

WHEREFORE, the petition is DISMISSED for lack of merit.

No costs.

SO ORDERED.

ADOLFO S. AZCUNAAssociate Justice

THIRD DIVISION

G.R. No. 172231             February 12, 2007

COMMISSIONER OF INTERNAL REVENUE, Petitioner, vs.ISABELA CULTURAL CORPORATION, Respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

Petitioner Commissioner of Internal Revenue (CIR) assails the September 30, 2005 Decision of the Court of Appeals in CA-G.R. SP No. 78426 affirming the February 26, 2003 Decision of the Court of Tax Appeals (CTA) in CTA Case No. 5211, which cancelled and set aside the Assessment Notices for deficiency income tax and expanded withholding tax issued by the Bureau of Internal Revenue (BIR) against respondent Isabela Cultural Corporation (ICC).

The facts show that on February 23, 1990, ICC, a domestic corporation, received from the BIR Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986.

The deficiency income tax of P333,196.86, arose from:

(1) The BIR’s disallowance of ICC’s claimed expense deductions for professional and security services billed to and paid by ICC in 1986, to wit:

(a) Expenses for the auditing services of SGV & Co., for the year ending December 31, 1985;

(b) Expenses for the legal services [inclusive of retainer fees] of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson for the years 1984 and 1985.

(c) Expense for security services of El Tigre Security & Investigation Agency for the months of April and May 1986.

(2) The alleged understatement of ICC’s interest income on the three promissory notes due from Realty Investment, Inc.

The deficiency expanded withholding tax of P4,897.79 (inclusive of interest and surcharge) was allegedly due to the failure of ICC to withhold 1% expanded withholding tax on its claimed P244,890.00 deduction for security services.

On March 23, 1990, ICC sought a reconsideration of the subject assessments. On February 9, 1995, however, it received a final notice before seizure demanding payment of the amounts stated in the said notices. Hence, it brought the case to the CTA which held that the petition is premature because the final notice of assessment cannot be considered as a final decision appealable to the tax court. This was reversed by the Court of Appeals holding that a demand letter of the BIR reiterating the payment of deficiency tax, amounts to a final decision on the protested assessment and may therefore be questioned before the CTA. This conclusion was sustained by this Court on July 1, 2001, in G.R. No. 135210. The case was thus remanded to the CTA for further proceedings.

On February 26, 2003, the CTA rendered a decision canceling and setting aside the assessment notices issued against ICC. It held that the claimed deductions for professional and security services were properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the amount thereof could not be determined at that time.

The CTA also held that ICC did not understate its interest income on the subject promissory notes. It found that it was the BIR which made an overstatement of said income when it compounded the interest income receivable by ICC from the promissory notes of Realty Investment, Inc., despite the absence of a stipulation in the contract providing for a compounded interest; nor of a circumstance, like delay in payment or breach of contract, that would justify the application of compounded interest.

Likewise, the CTA found that ICC in fact withheld 1% expanded withholding tax on its claimed deduction for security services as shown by the various payment orders and confirmation receipts it presented as evidence. The dispositive portion of the CTA’s Decision, reads:

WHEREFORE, in view of all the foregoing, Assessment Notice No. FAS-1-86-90-000680 for deficiency income tax in the amount of P333,196.86, and Assessment Notice No. FAS-1-86-90-000681 for deficiency expanded withholding tax in the amount of P4,897.79, inclusive of surcharges and interest, both for the taxable year 1986, are hereby CANCELLED and SET ASIDE.

SO ORDERED.

Petitioner filed a petition for review with the Court of Appeals, which affirmed the CTA decision, holding that although the professional services (legal and auditing services) were rendered to ICC in 1984 and 1985, the cost of the services was not yet determinable at that time, hence, it could be considered as deductible expenses only in 1986 when ICC received the billing statements for said services. It further ruled that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc., and that ICC properly withheld and remitted taxes on the payments for security services for the taxable year 1986.

Hence, petitioner, through the Office of the Solicitor General, filed the instant petition contending that since ICC is using the accrual method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have been declared as deductions from income during the said years and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year 1986. As to the alleged deficiency interest income and failure to withhold expanded withholding tax assessment, petitioner invoked the presumption that the assessment notices issued by the BIR are valid.

The issue for resolution is whether the Court of Appeals correctly: (1) sustained the deduction of the expenses for professional and security services from ICC’s gross income; and (2) held that ICC did not understate its interest income from the promissory notes of Realty Investment, Inc; and that ICC withheld the required 1% withholding tax from the deductions for security services.

The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers.

The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the taxable year in which ‘paid or accrued’ or ‘paid or incurred’, dependent upon the method of accounting upon the basis of which the net income is computed x x x".

Accounting methods for tax purposes comprise a set of rules for determining when and how to report income and deductions. In the instant case, the accounting method used by ICC is the accrual method.

Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year.

The accrual method relies upon the taxpayer’s right to receive amounts or its obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment.

For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability.

The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The all-events test is satisfied where computation remains uncertain, if its basis is unchangeable; the test is satisfied where a computation may be unknown, but is not as much as unknowable, within the taxable year. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount.

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year.

[16] Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or deduction

Corollarily, it is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority; and one who claims an exemption must be able to justify the same by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications. And since a deduction for income tax purposes partakes of the nature of a tax exemption, then it must also be strictly construed.

In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICC’s tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960’s. From the nature of the claimed deductions and the span of time during which the firm was retained, ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time legal consultant.

As previously stated, the accrual method presents largely a question of fact and that the taxpayer bears the burden of establishing the accrual of an expense or income. However, ICC failed to discharge this burden. As to when the firm’s performance of its services in connection with the 1984 tax problems were completed, or whether ICC exercised reasonable diligence to inquire about the amount of its liability, or whether it does or does not possess the information necessary to compute the amount of said liability with reasonable accuracy, are questions of fact which ICC never established. It simply relied on the defense of delayed billing by the firm and the company, which under the circumstances, is not sufficient to exempt it from being charged with knowledge of the reasonable amount of the expenses for legal and auditing services.

In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said company would charge for its services.

ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income for the said year and were therefore properly disallowed by the BIR.

As to the expenses for security services, the records show that these expenses were incurred by ICC in 1986and could therefore be properly claimed as deductions for the said year.

Anent the purported understatement of interest income from the promissory notes of Realty Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no such understatement exists and that only simple interest computation and not a compounded one should have been applied by the BIR. There is indeed no stipulation between the latter and ICC on the

application of compounded interest. Under Article 1959 of the Civil Code, unless there is a stipulation to the contrary, interest due should not further earn interest.

Likewise, the findings of the CTA and the Court of Appeals that ICC truly withheld the required withholding tax from its claimed deductions for security services and remitted the same to the BIR is supported by payment order and confirmation receipts. Hence, the Assessment Notice for deficiency expanded withholding tax was properly cancelled and set aside.

In sum, Assessment Notice No. FAS-1-86-90-000680 in the amount of P333,196.86 for deficiency income tax should be cancelled and set aside but only insofar as the claimed deductions of ICC for security services. Said Assessment is valid as to the BIR’s disallowance of ICC’s expenses for professional services. The Court of Appeal’s cancellation of Assessment Notice No. FAS-1-86-90-000681 in the amount of P4,897.79 for deficiency expanded withholding tax, is sustained.

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

The case is remanded to the BIR for the computation of Isabela Cultural Corporation’s liability under Assessment Notice No. FAS-1-86-90-000680.

SO ORDERED.

G.R. No. 143672            April 24, 2003

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.GENERAL FOODS (PHILS.), INC., respondent.

CORONA, J.:

Petitioner Commissioner of Internal Revenue (Commissioner) assails the resolution1 of the Court of Appeals reversing the decision2 of the Court of Tax Appeals which in turn denied the protest filed by respondent General Foods (Phils.), Inc., regarding the assessment made against the latter for deficiency taxes.

The records reveal that, on June 14, 1985, respondent corporation, which is engaged in the manufacture of beverages such as "Tang," "Calumet" and "Kool-Aid," filed its income tax return for the fiscal year ending February 28, 1985. In said tax return, respondent corporation claimed as deduction, among other business expenses, the amount of P9,461,246 for media advertising for "Tang."

On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent corporation. Consequently, respondent corporation was assessed deficiency income taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration but the same was denied.

On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the appeal was dismissed:

With such a gargantuan expense for the advertisement of a singular product, which even excludes "other advertising and promotions" expenses, we are not prepared to accept that such amount is reasonable "to stimulate the current sale of merchandise" regardless of Petitioner’s explanation that such expense "does not connote unreasonableness considering the grave economic situation taking place after the Aquino assassination characterized by capital fight, strong deterioration of the purchasing power of the Philippine peso and the slacking demand for consumer products" (Petitioner’s Memorandum, CTA Records, p. 273). We are not convinced with such an explanation. The staggering expense led us to believe that such expenditure was incurred "to create or maintain some form of good will for the taxpayer’s trade or business or for the industry or profession of which the taxpayer is a member." The term "good will" can hardly be said to have any precise signification; it is generally used to denote the benefit arising from connection and reputation (Words and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III. App. 294). As held in the case of Welch vs. Helvering, efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expenses but capital expenditures. (Atlas Mining and Development Corp. vs. Commissioner of Internal Revenue, supra). For

sure such expenditure was meant not only to generate present sales but more for future and prospective benefits. Hence, "abnormally large expenditures for advertising are usually to be spread over the period of years during which the benefits of the expenditures are received" (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we hereby RESOLVE to DISMISS the instant petition for lack of merit and ORDER the Petitioner to pay the respondent Commissioner the assessed amount of P2,635,141.42 representing its deficiency income tax liability for the fiscal year ended February 28, 1985."3

Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which rendered a decision reversing and setting aside the decision of the Court of Tax Appeals:

Since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same should be allowed.

WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby GRANTED. Accordingly, the Decision, dated 8 February 1994 of respondent Court of Tax Appeals is REVERSED and SET ASIDE and the letter, dated 31 May 1988 of respondent Commissioner of Internal Revenue is CANCELLED.

SO ORDERED.4

Thus, the instant petition, wherein the Commissioner presents for the Court’s consideration a lone issue: whether or not the subject media advertising expense for "Tang" incurred by respondent corporation was an ordinary and necessary expense fully deductible under the National Internal Revenue Code (NIRC).

It is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority;5 and he who claims an exemption must be able to justify his claim by the clearest grant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vague implications.6

Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed, then deductions must also be strictly construed.

We then proceed to resolve the singular issue in the case at bar. Was the media advertising expense for "Tang" paid or incurred by respondent corporation for the fiscal year ending February 28, 1985 "necessary and ordinary," hence, fully deductible under the NIRC? Or was it a capital expenditure, paid in order to create "goodwill and reputation" for respondent corporation and/or its products, which should have been amortized over a reasonable period?

Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:

(A) Expenses.-

(1) Ordinary and necessary trade, business or professional expenses.-

(a) In general.- There shall be allowed as deduction from gross income all ordinary and necessary expenses paid or incurred during the taxable year in carrying on, or

which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession.

Simply put, to be deductible from gross income, the subject advertising expense must comply with the following requisites: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers.7

The parties are in agreement that the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was necessary. However, their views conflict as to whether or not it was ordinary. To be deductible, an advertising expense should not only be necessary but also ordinary. These two requirements must be met.

The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the two conditions set by U.S. jurisprudence: first, "reasonableness" of the amount incurred and second, the amount incurred must not be a capital outlay to create "goodwill" for the product and/or private respondent’s business. Otherwise, the expense must be considered a capital expenditure to be spread out over a reasonable time.

We agree.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There being no hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: the type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation.

In the case at bar, the P9,461,246 claimed as media advertising expense for "Tang" alone was almost one-half of its total claim for "marketing expenses." Aside from that, respondent-corporation also claimed P2,678,328 as "other advertising and promotions expense" and another P1,548,614, for consumer promotion.

Furthermore, the subject P9,461,246 media advertising expense for "Tang" was almost double the amount of respondent corporation’s P4,640,636 general and administrative expenses.

We find the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it is necessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2) advertising designed to stimulate the future sale of merchandise or use of services. The second type involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer’s trade or business or for the industry or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time.

We agree with the Court of Tax Appeals that the subject advertising expense was of the second kind. Not only was the amount staggering; the respondent corporation itself also admitted, in its letter protest8 to the Commissioner of Internal Revenue’s assessment, that the subject media expense was incurred in order to protect respondent corporation’s brand franchise, a critical point during the period under review.

The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s property. This is a capital expenditure which should be spread out over a reasonable period of time.9

Respondent corporation’s venture to protect its brand franchise was tantamount to efforts to establish a reputation. This was akin to the acquisition of capital assets and therefore expenses related thereto were not to be considered as business expenses but as capital expenditures.10

True, it is the taxpayer’s prerogative to determine the amount of advertising expenses it will incur and where to apply them.11 Said prerogative, however, is subject to certain considerations. The first relates to the extent to which the expenditures are actually capital outlays; this necessitates an inquiry into the nature or purpose of such expenditures.12 The second, which must be applied in harmony with the first, relates to whether the expenditures are ordinary and necessary. Concomitantly, for an expense to be considered ordinary, it must be reasonable in amount. The Court of Tax Appeals ruled that respondent corporation failed to meet the two foregoing limitations.

We find said ruling to be well founded. Respondent corporation incurred the subject advertising expense in order to protect its brand franchise. We consider this as a capital outlay since it created goodwill for its business and/or product. The P9,461,246 media advertising expense for the promotion of a single product, almost one-half of petitioner corporation’s entire claim for marketing expenses for that year under review, inclusive of other advertising and promotion expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly unreasonable.

It has been a long standing policy and practice of the Court to respect the conclusions of quasi-judicial agencies such as the Court of Tax Appeals, a highly specialized body specifically created for the purpose of reviewing tax cases. The CTA, by the nature of its functions, is dedicated exclusively to the study and consideration of tax problems. It has necessarily developed an expertise on the subject. We extend due consideration to its opinion unless there is an abuse or improvident exercise of authority.13 Since there is none in the case at bar, the Court adheres to the findings of the CTA.

Accordingly, we find that the Court of Appeals committed reversible error when it declared the subject media advertising expense to be deductible as an ordinary and necessary expense on the ground that "it has not been established that the item being claimed as deduction is excessive." It is not incumbent upon the taxing authority to prove that the amount of items being claimed is unreasonable. The burden of proof to establish the validity of claimed deductions is on the taxpayer.14 In the present case, that burden was not discharged satisfactorily.

WHEREFORE, premises considered, the instant petition is GRANTED. The assailed decision of the Court of Appeals is hereby REVERSED and SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code, respondent General Foods (Phils.), Inc. is hereby ordered to pay its deficiency income tax in the amount of P2,635,141.42, plus 25% surcharge for late payment and 20% annual interest computed from August 25, 1989, the date of the denial of its protest, until the same is fully paid.

SO ORDERED.

G.R. No. L-24059      November 28, 1969

C. M. HOSKINS & CO., INC., petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, respondent.

Ross, Salcedo, Del Rosario, Bito and Misa for petitioner.Office of the Solicitor General Arturo A. Alafriz, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney Michaelina R. Balasbas for respondent.

TEEHANKEE, J.:

We uphold in this taxpayer's appeal the Tax Court's ruling that payment by the taxpayer to its controlling stockholder of 50% of its supervision fees or the amount of P99,977.91 is not a deductible ordinary and necessary expense and should be treated as a distribution of earnings and profits of the taxpayer.

Petitioner, a domestic corporation engaged in the real estate business as brokers, managing agents and administrators, filed its income tax return for its fiscal year ending September 30, 1957 showing a net income of P92,540.25 and a tax liability due thereon of P18,508.00, which it paid in due course. Upon verification of its return, respondent Commissioner of Internal Revenue, disallowed four items of deduction in petitioner's tax returns and assessed against it an income tax deficiency in the amount of P28,054.00 plus interests. The Court of Tax Appeals upon reviewing the assessment at the taxpayer's petition, upheld respondent's disallowance of the principal item of petitioner's having paid to Mr. C. M. Hoskins, its founder and controlling stockholder the amount of P99,977.91 representing 50% of supervision fees earned by it and set aside respondent's disallowance of three other minor items. The Tax Court therefore determined petitioner's tax deficiency to be in the amount of P27,145.00 and on November 8, 1964 rendered judgment against it, as follows:

WHEREFORE, premises considered, the decision of the respondent is hereby modified. Petitioner is ordered to pay to the latter or his representative the sum of P27,145.00, representing deficiency income tax for the year 1957, plus interest at 1/2% per month from June 20, 1959 to be computed in accordance with the provisions of Section 51(d) of the National Internal Revenue Code. If the deficiency tax is not paid within thirty (30) days from the date this decision becomes final, petitioner is also ordered to pay surcharge and interest as provided for in Section 51 (e) of the Tax Code, without costs.

Petitioner questions in this appeal the Tax Court's findings that the disallowed payment to Hoskins was an inordinately large one, which bore a close relationship to the recipient's dominant stockholdings and therefore amounted in law to a distribution of its earnings and profits.

We find no merit in petitioner's appeal.

As found by the Tax Court, "petitioner was founded by Mr. C. M. Hoskins in 1937, with a capital stock of 1,000 shares at a par value of P1.00 each share; that of these 1,000 shares, Mr. C. M. Hoskins owns 996 shares (the other 4 shares being held by the other four officers of the corporation), which constitute exactly 99.6% of the total authorized capital stock (p. 92, t.s.n.); that during the first four years of its existence, Mr. C. M. Hoskins was the President, but during the taxable period in question, that is, from October 1, 1956 to September 30, 1957, he was the chairman of the Board of Directors and salesman-broker for the company (p. 93, t.s.n.); that as chairman of the Board of Directors, he received a salary of P3,750.00 a month, plus a salary bonus of about P40,000.00 a year (p. 94, t.s.n.); that he was also a stockholder and officer of the Paradise Farms, Inc. and Realty Investments, Inc., from which petitioner derived a large portion of its income in the form of supervision fees and commissions earned on sales of lots (pp. 97-99, t.s.n.; Financial Statements, attached to Exhibit '1', p. 11, BIR rec.); that as chairman of the Board of Directors of petitioner, his duties were: "To act as a salesman; as a director, preside over meetings and to get all of the real estate business I could for the company by negotiating sales, purchases, making appraisals, raising funds to finance real estate operations where that was necessary' (p. 96, t.s.n.); that he was familiar with the contract entered into by the petitioner with the Paradise Farms, Inc. and the Realty Investments, Inc. by the terms of which petitioner was 'to program the development, arrange financing, plan the proposed subdivision as outlined in the prospectus of Paradise Farms, Inc., arrange contract for road constructions, with the provision of water supply to all of the lots and in general to serve as managing agents for the Paradise Farms, Inc. and subsequently for the Realty Investment, Inc." (pp. 96-97. t.s.n.)

Considering that in addition to being Chairman of the board of directors of petitioner corporation, which bears his name, Hoskins, who owned 99.6% of its total authorized capital stock while the four other officers-stockholders of the firm owned a total of four-tenths of 1%, or one-tenth of 1% each, with their respective nominal shareholdings of one share each was also salesman-broker for his company, receiving a 50% share of the sales commissions earned by petitioner, besides his monthly salary of P3,750.00 amounting to an annual compensation of P45,000.00 and an annual salary bonus of P40,000.00, plus free use of the company car and receipt of other similar allowances and benefits, the Tax Court correctly ruled that the payment by petitioner to Hoskins of the additional sum of P99,977.91 as his equal or 50% share of the 8% supervision fees received by petitioner as managing agents of the real estate, subdivision projects of Paradise Farms, Inc. and Realty Investments, Inc. was inordinately large and could not be accorded the treatment of ordinary and necessary expenses allowed as deductible items within the purview of Section 30 (a) (i) of the Tax Code.

If such payment of P99,977.91 were to be allowed as a deductible item, then Hoskins would receive on these three items alone (salary, bonus and supervision fee) a total of P184,977.91, which would be double the petitioner's reported net income for the year of P92,540.25. As correctly observed by respondent. If independently, a one-time P100,000.00-fee to plan and lay down the rules for supervision of a subdivision project were to be paid to an experienced realtor such as Hoskins, its fairness and deductibility by the taxpayer could be conceded; but here 50% of the supervision fee of petitioner was being paid by it to Hoskins every year since 1955 up to 1963 and for as long as its contract with the subdivision owner subsisted, regardless of whether services were actually rendered by Hoskins, since his services to petitioner included such planning and supervision and were already handsomely paid for by petitioner.

The fact that such payment was authorized by a standing resolution of petitioner's board of directors, since "Hoskins had personally conceived and planned the project" cannot change the picture. There could be no question that as Chairman of the board and practically an absolutely controlling stockholder of petitioner, holding 99.6% of its stock, Hoskins wielded tremendous power and influence in the formulation and making of the company's policies and decisions. Even just as board chairman, going by petitioner's own enumeration of the powers of the office, Hoskins, could exercise great power and influence within the corporation, such as directing the policy of the corporation, delegating powers to the president and advising the corporation in determining executive salaries, bonus plans and pensions, dividend policies, etc.1

Petitioner's invoking of its policy since its incorporation of sharing equally sales commissions with its salesmen, in accordance with its board resolution of June 18, 1946, is equally untenable. Petitioner's Sales Regulations provide:

Compensation of Salesmen

8. Schedule I — In the case of sales to prospects discovered and worked by a salesman, even though the closing is done by or with the help of the Sales Manager or other members of the staff, the salesmen get one-half (1/2) of the total commission received by the Company, but not exceeding five percent (5%). In the case of subdivisions, when the office commission covers general supervision, the 1/2-rule does not apply, the salesman's share being stipulated in the case of each subdivision. In most cases the salesman's share is 4%. (Exh. "N-1").2

It will be readily seen therefrom that when the petitioner's commission covers general supervision, it is provided that the 1/2 rule of equal sharing of the sales commissions does not apply and that the salesman's share is stipulated in the case of each subdivision. Furthermore, what is involved here is not Hoskins' salesman's share in the petitioner's 12% sales commission, which he presumably collected also from petitioner without respondent's questioning it, but a 50% share besides in petitioner's planning and supervision fee of 8% of the gross sales, as mentioned above. This is evident from petitioner's board's resolution of July 14, 1953 (Exhibit 7), wherein it is recited that in addition to petitioner's sales commission of 12% of gross sales, the subdivision owners were paying to petitioner 8% of gross sales as supervision fee, and a collection fee of 5% of gross collections, or total fees of 25% of gross sales.

The case before us is similar to previous cases of disallowances as deductible items of officers' extra fees, bonuses and commissions, upheld by this Court as not being within the purview of ordinary and necessary expenses and not passing the test of reasonable compensation.3 In Kuenzle & Streiff, Inc. vs. Commissioner of Internal Revenue decided by this Court on May 29, 1969,4 we reaffirmed the test of reasonableness, enunciated in the earlier 1967 case involving the same parties, that: "It is a general rule that 'Bonuses to employees made in good faith and as additional compensation for the services actually rendered by the employees are deductible, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered' (4 Mertens Law of Federal Income Taxation, Sec. 25.50, p. 410). The conditions precedent to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered; and (3) the bonuses, when added to the salaries, are 'reasonable . . . when measured by the amount and quality of the services performed with relation to the business of the particular taxpayer' (Idem., Sec. 25, 44, p. 395).

"There is no fixed test for determining the reasonableness of a given bonus as compensation. This depends upon many factors, one of them being 'the amount and quality of the services performed with relation to the business.' Other tests suggested are: payment must be 'made in good faith'; 'the

character of the taxpayer's business, the volume and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation'; 'the size of the particular business'; 'the employees' qualifications and contributions to the business venture'; and 'general economic conditions' (4 Mertens, Law of Federal Income Taxation, Secs. 25.44, 25.49, 25.50, 25.51, pp. 407-412). However, 'in determining whether the particular salary or compensation payment is reasonable, the situation must be considered as whole. Ordinarily, no single factor is decisive. . . . it is important to keep in mind that it seldom happens that the application of one test can give satisfactory answer, and that ordinarily it is the interplay of several factors, properly weighted for the particular case, which must furnish the final answer."

Petitioner's case fails to pass the test. On the right of the employer as against respondent Commissioner to fix the compensation of its officers and employees, we there held further that while the employer's right may be conceded, the question of the allowance or disallowance thereof as deductible expenses for income tax purposes is subject to determination by respondent Commissioner of Internal Revenue. Thus: "As far as petitioner's contention that as employer it has the right to fix the compensation of its officers and employees and that it was in the exercise of such right that it deemed proper to pay the bonuses in question, all that We need say is this: that right may be conceded, but for income tax purposes the employer cannot legally claim such bonuses as deductible expenses unless they are shown to be reasonable. To hold otherwise would open the gate of rampant tax evasion.

"Lastly, We must not lose sight of the fact that the question of allowing or disallowing as deductible expenses the amounts paid to corporate officers by way of bonus is determined by respondent exclusively for income tax purposes. Concededly, he has no authority to fix the amounts to be paid to corporate officers by way of basic salary, bonus or additional remuneration — a matter that lies more or less exclusively within the sound discretion of the corporation itself. But this right of the corporation is, of course, not absolute. It cannot exercise it for the purpose of evading payment of taxes legitimately due to the State."

Finally, it should be noted that we have here a case practically of a sole proprietorship of C. M. Hoskins, who however chose to incorporate his business with himself holding virtually absolute control thereof with 99.6% of its stock with four other nominal shareholders holding one share each. Having chosen to use the corporate form with its legal advantages of a separate corporate personality as distinguished from his individual personality, the corporation so created, i.e., petitioner, is bound to comport itself in accordance with corporate norms and comply with its corporate obligations. Specifically, it is bound to pay the income tax imposed by law on corporations and may not legally be permitted, by way of corporate resolutions authorizing payment of inordinately large commissions and fees to its controlling stockholder, to dilute and diminish its corresponding corporate tax liability.

ACCORDINGLY, the decision appealed from is hereby affirmed, with costs in both instances against petitioner.

Concepcion, C.J., Reyes, J.B.L., Dizon, Makalintal, Zaldivar, Sanchez, Castro, Fernando and Barredo, JJ.,concur.

G.R. No. 148187             April 16, 2008

PHILEX MINING CORPORATION, petitioner, vs.COMMISSIONER OF INTERNAL REVENUE, respondent.

D E C I S I O N

YNARES-SANTIAGO, J.:

This is a petition for review on certiorari of the June 30, 2000 Decision of the Court of Appeals in CA-G.R. SP No. 49385, which affirmed the Decision of the Court of Tax Appeals in C.T.A. Case No. 5200. Also assailed is the April 3, 2001 Resolution denying the motion for reconsideration.

The facts of the case are as follows:

On April 16, 1971, petitioner Philex Mining Corporation (Philex Mining), entered into an agreement Baguio Gold Mining Company ("Baguio Gold") for the former to manage and operate the latter’s mining claim, known as the Sto. Nino mine, located in Atok and Tublay, Benguet Province. The parties’ agreement was denominated as "Power of Attorney" and provided for the following terms:

4. Within three (3) years from date thereof, the PRINCIPAL (Baguio Gold) shall make available to the MANAGERS (Philex Mining) up to ELEVEN MILLION PESOS (P11,000,000.00), in such amounts as from time to time may be required by the MANAGERS within the said 3-year period, for use in the MANAGEMENT of the STO. NINO MINE. The said ELEVEN MILLION PESOS (P11,000,000.00) shall be deemed, for internal audit purposes, as the owner’s account in the Sto. Nino PROJECT. Any part of any income of the PRINCIPAL from the STO. NINO MINE, which is left with the Sto. Nino PROJECT, shall be added to such owner’s account.

5. Whenever the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO. NINO MINE, they may transfer their own funds or property to the Sto. Nino PROJECT, in accordance with the following arrangements:

(a) The properties shall be appraised and, together with the cash, shall be carried by the Sto. Nino PROJECT as a special fund to be known as the MANAGERS’ account.

(b) The total of the MANAGERS’ account shall not exceed P11,000,000.00, except with prior approval of the PRINCIPAL; provided, however, that if the compensation of the MANAGERS as herein provided cannot be paid in cash from the Sto. Nino PROJECT, the amount not so paid in cash shall be added to the MANAGERS’ account.

(c) The cash and property shall not thereafter be withdrawn from the Sto. Nino PROJECT until termination of this Agency.

(d) The MANAGERS’ account shall not accrue interest. Since it is the desire of the PRINCIPAL to extend to the MANAGERS the benefit of subsequent appreciation of property, upon a projected termination of this Agency, the ratio which the MANAGERS’ account has to the owner’s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims, shall be transferred to the MANAGERS, except that such transferred assets shall not include mine development, roads, buildings, and similar property which will be valueless, or of slight value, to the MANAGERS. The MANAGERS can, on the other hand, require at their option that property originally transferred by them to the Sto. Nino PROJECT be re-transferred to them. Until such assets are transferred to the MANAGERS, this Agency shall remain subsisting.

x x x x

12. The compensation of the MANAGER shall be fifty per cent (50%) of the net profit of the Sto. Nino PROJECT before income tax. It is understood that the MANAGERS shall pay income tax on their compensation, while the PRINCIPAL shall pay income tax on the net profit of the Sto. Nino PROJECT after deduction therefrom of the MANAGERS’ compensation.

x x x x

16. The PRINCIPAL has current pecuniary obligation in favor of the MANAGERS and, in the future, may incur other obligations in favor of the MANAGERS. This Power of Attorney has been executed as security for the payment and satisfaction of all such obligations of the PRINCIPAL in favor of the MANAGERS and as a means to fulfill the same. Therefore, this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account. After all obligations of the PRINCIPAL in favor of the MANAGERS have been paid and satisfied in full, this Agency shall be revocable by the PRINCIPAL upon 36-month notice to the MANAGERS.

17. Notwithstanding any agreement or understanding between the PRINCIPAL and the MANAGERS to the contrary, the MANAGERS may withdraw from this Agency by giving 6-month notice to the PRINCIPAL. The MANAGERS shall not in any manner be held liable to the PRINCIPAL by reason alone of such withdrawal. Paragraph 5(d) hereof shall be operative in case of the MANAGERS’ withdrawal.

In the course of managing and operating the project, Philex Mining made advances of cash and property in accordance with paragraph 5 of the agreement. However, the mine suffered continuing losses over the years which resulted to petitioner’s withdrawal as manager of the mine on January 28, 1982 and in the eventual cessation of mine operations on February 20, 1982. Thereafter, on September 27, 1982, the parties executed a "Compromise with Dation in Payment" wherein Baguio Gold admitted an indebtedness to petitioner in the amount of P179,394,000.00 and agreed to pay

the same in three segments by first assigning Baguio Gold’s tangible assets to petitioner, transferring to the latter Baguio Gold’s equitable title in its Philodrill assets and finally settling the remaining liability through properties that Baguio Gold may acquire in the future.

On December 31, 1982, the parties executed an "Amendment to Compromise with Dation in Paymentwhere the parties determined that Baguio Gold’s indebtedness to petitioner actually amounted to P259,137,245.00, which sum included liabilities of Baguio Gold to other creditors that petitioner had assumed as guarantor. These liabilities pertained to long-term loans amounting to US$11,000,000.00 contracted by Baguio Gold from the Bank of America NT & SA and Citibank N.A. This time, Baguio Gold undertook to pay petitioner in two segments by first assigning its tangible assets for P127,838,051.00 and then transferring its equitable title in its Philodrill assets for P16,302,426.00. The parties then ascertained that Baguio Gold had a remaining outstanding indebtedness to petitioner in the amount of P114,996,768.00.

Subsequently, petitioner wrote off in its 1982 books of account the remaining outstanding indebtedness of Baguio Gold by charging P112,136,000.00 to allowances and reserves that were set up in 1981 and P2,860,768.00 to the 1982 operations.

In its 1982 annual income tax return, petitioner deducted from its gross income the amount of P112,136,000.00 as "loss on settlement of receivables from Baguio Gold against reserves and allowances." However, the Bureau of Internal Revenue (BIR) disallowed the amount as deduction for bad debt and assessed petitioner a deficiency income tax of P62,811,161.39.

Petitioner protested before the BIR arguing that the deduction must be allowed since all requisites for a bad debt deduction were satisfied, to wit: (a) there was a valid and existing debt; (b) the debt was ascertained to be worthless; and (c) it was charged off within the taxable year when it was determined to be worthless.

Petitioner emphasized that the debt arose out of a valid management contract it entered into with Baguio Gold. The bad debt deduction represented advances made by petitioner which, pursuant to the management contract, formed part of Baguio Gold’s "pecuniary obligations" to petitioner. It also included payments made by petitioner as guarantor of Baguio Gold’s long-term loans which legally entitled petitioner to be subrogated to the rights of the original creditor.

Petitioner also asserted that due to Baguio Gold’s irreversible losses, it became evident that it would not be able to recover the advances and payments it had made in behalf of Baguio Gold. For a debt to be considered worthless, petitioner claimed that it was neither required to institute a judicial action for collection against the debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough that a taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable means to collect.

On October 28, 1994, the BIR denied petitioner’s protest for lack of legal and factual basis. It held that the alleged debt was not ascertained to be worthless since Baguio Gold remained existing and had not filed a petition for bankruptcy; and that the deduction did not consist of a valid and subsisting debt considering that, under the management contract, petitioner was to be paid fifty percent (50%) of the project’s net profit.

Petitioner appealed before the Court of Tax Appeals (CTA) which rendered judgment, as follows:

WHEREFORE, in view of the foregoing, the instant Petition for Review is hereby DENIED for lack of merit. The assessment in question, viz: FAS-1-82-88-003067 for deficiency income tax in the amount of P62,811,161.39 is hereby AFFIRMED.

ACCORDINGLY, petitioner Philex Mining Corporation is hereby ORDERED to PAY respondent Commissioner of Internal Revenue the amount of P62,811,161.39, plus, 20% delinquency interest due computed from February 10, 1995, which is the date after the 20-day grace period given by the respondent within which petitioner has to pay the deficiency amount x x x up to actual date of payment.

SO ORDERED.

The CTA rejected petitioner’s assertion that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead characterized the advances as petitioner’s investment in a partnership with Baguio Gold for the development and exploitation of the Sto. Nino mine. The CTA held that the "Power of Attorney" executed by petitioner and Baguio Gold was actually a partnership agreement. Since the advanced amount partook of the nature of an investment, it could not be deducted as a bad debt from petitioner’s gross income.

The CTA likewise held that the amount paid by petitioner for the long-term loan obligations of Baguio Gold could not be allowed as a bad debt deduction. At the time the payments were made, Baguio Gold was not in default since its loans were not yet due and demandable. What petitioner did was to pre-pay the loans as evidenced by the notice sent by Bank of America showing that it was merely demanding payment of the installment and interests due. Moreover, Citibank imposed and collected a "pre-termination penalty" for the pre-payment.

The Court of Appeals affirmed the decision of the CTA. Hence, upon denial of its motion for reconsideration, petitioner took this recourse under Rule 45 of the Rules of Court, alleging that:

I.

The Court of Appeals erred in construing that the advances made by Philex in the management of the Sto. Nino Mine pursuant to the Power of Attorney partook of the nature of an investment rather than a loan.

II.

The Court of Appeals erred in ruling that the 50%-50% sharing in the net profits of the Sto. Nino Mine indicates that Philex is a partner of Baguio Gold in the development of the Sto. Nino Mine notwithstanding the clear absence of any intent on the part of Philex and Baguio Gold to form a partnership.

III.

The Court of Appeals erred in relying only on the Power of Attorney and in completely disregarding the Compromise Agreement and the Amended Compromise Agreement when it construed the nature of the advances made by Philex.

IV.

The Court of Appeals erred in refusing to delve upon the issue of the propriety of the bad debts write-off.14

Petitioner insists that in determining the nature of its business relationship with Baguio Gold, we should not only rely on the "Power of Attorney", but also on the subsequent "Compromise with

Dation in Payment" and "Amended Compromise with Dation in Payment" that the parties executed in 1982. These documents, allegedly evinced the parties’ intent to treat the advances and payments as a loan and establish a creditor-debtor relationship between them.

The petition lacks merit.

The lower courts correctly held that the "Power of Attorney" is the instrument that is material in determining the true nature of the business relationship between petitioner and Baguio Gold. Before resort may be had to the two compromise agreements, the parties’ contractual intent must first be discovered from the expressed language of the primary contract under which the parties’ business relations were founded. It should be noted that the compromise agreements were mere collateral documents executed by the parties pursuant to the termination of their business relationship created under the "Power of Attorney". On the other hand, it is the latter which established the juridical relation of the parties and defined the parameters of their dealings with one another.

The execution of the two compromise agreements can hardly be considered as a subsequent or contemporaneous act that is reflective of the parties’ true intent. The compromise agreements were executed eleven years after the "Power of Attorney" and merely laid out a plan or procedure by which petitioner could recover the advances and payments it made under the "Power of Attorney". The parties entered into the compromise agreements as a consequence of the dissolution of their business relationship. It did not define that relationship or indicate its real character.

An examination of the "Power of Attorney" reveals that a partnership or joint venture was indeed intended by the parties. Under a contract of partnership, two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves While a corporation, like petitioner, cannot generally enter into a contract of partnership unless authorized by law or its charter, it has been held that it may enter into a joint venture which is akin to a particular partnership:

The legal concept of a joint venture is of common law origin. It has no precise legal definition, but it has been generally understood to mean an organization formed for some temporary purpose. x x x It is in fact hardly distinguishable from the partnership, since their elements are similar – community of interest in the business, sharing of profits and losses, and a mutual right of control. x x x The main distinction cited by most opinions in common law jurisdictions is that the partnership contemplates a general business with some degree of continuity, while the joint venture is formed for the execution of a single transaction, and is thus of a temporary nature. x x x This observation is not entirely accurate in this jurisdiction, since under the Civil Code, a partnership may be particular or universal, and a particular partnership may have for its object a specific undertaking. x x x It would seem therefore that under Philippine law, a joint venture is a form of partnership and should be governed by the law of partnerships. The Supreme Court has however recognized a distinction between these two business forms, and has held that although a corporation cannot enter into a partnership contract, it may however engage in a joint venture with others. x x x (Citations omitted

Perusal of the agreement denominated as the "Power of Attorney" indicates that the parties had intended to create a partnership and establish a common fund for the purpose. They also had a joint interest in the profits of the business as shown by a 50-50 sharing in the income of the mine.

Under the "Power of Attorney", petitioner and Baguio Gold undertook to contribute money, property and industry to the common fund known as the Sto. Niño mine. In this regard, we note that there is a substantive equivalence in the respective contributions of the parties to the development and

operation of the mine. Pursuant to paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute equally to the joint venture assets under their respective accounts. Baguio Gold would contribute P11M under its owner’s account plus any of its income that is left in the project, in addition to its actual mining claim. Meanwhile, petitioner’s contribution would consist of its expertise in the management and operation of mines, as well as the manager’s account which is comprised of P11M in funds and property and petitioner’s "compensation" as manager that cannot be paid in cash.

However, petitioner asserts that it could not have entered into a partnership agreement with Baguio Gold because it did not "bind" itself to contribute money or property to the project; that under paragraph 5 of the agreement, it was only optional for petitioner to transfer funds or property to the Sto. Niño project "(w)henever the MANAGERS shall deem it necessary and convenient in connection with the MANAGEMENT of the STO. NIÑO MINE."

The wording of the parties’ agreement as to petitioner’s contribution to the common fund does not detract from the fact that petitioner transferred its funds and property to the project as specified in paragraph 5, thus rendering effective the other stipulations of the contract, particularly paragraph 5(c) which prohibits petitioner from withdrawing the advances until termination of the parties’ business relations. As can be seen, petitioner became bound by its contributions once the transfers were made. The contributions acquired an obligatory nature as soon as petitioner had chosen to exercise its option under paragraph 5.

There is no merit to petitioner’s claim that the prohibition in paragraph 5(c) against withdrawal of advances should not be taken as an indication that it had entered into a partnership with Baguio Gold; that the stipulation only showed that what the parties entered into was actually a contract of agency coupled with an interest which is not revocable at will and not a partnership.

In an agency coupled with interest, it is the agency that cannot be revoked or withdrawn by the principal due to an interest of a third party that depends upon it, or the mutual interest of both principal and agent.19 In this case, the non-revocation or non-withdrawal under paragraph 5(c) applies to the advances made by petitioner who is supposedly the agent and not the principal under the contract. Thus, it cannot be inferred from the stipulation that the parties’ relation under the agreement is one of agency coupled with an interest and not a partnership.

Neither can paragraph 16 of the agreement be taken as an indication that the relationship of the parties was one of agency and not a partnership. Although the said provision states that "this Agency shall be irrevocable while any obligation of the PRINCIPAL in favor of the MANAGERS is outstanding, inclusive of the MANAGERS’ account," it does not necessarily follow that the parties entered into an agency contract coupled with an interest that cannot be withdrawn by Baguio Gold.

It should be stressed that the main object of the "Power of Attorney" was not to confer a power in favor of petitioner to contract with third persons on behalf of Baguio Gold but to create a business relationship between petitioner and Baguio Gold, in which the former was to manage and operate the latter’s mine through the parties’ mutual contribution of material resources and industry. The essence of an agency, even one that is coupled with interest, is the agent’s ability to represent his principal and bring about business relations between the latter and third persons. Where representation for and in behalf of the principal is merely incidental or necessary for the proper discharge of one’s paramount undertaking under a contract, the latter may not necessarily be a contract of agency, but some other agreement depending on the ultimate undertaking of the parties. In this case, the totality of the circumstances and the stipulations in the parties’ agreement indubitably lead to the conclusion that a partnership was formed between petitioner and Baguio Gold.

First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination of the parties’ business relations, "the ratio which the MANAGER’S account has to the owner’s account will be determined, and the corresponding proportion of the entire assets of the STO. NINO MINE, excluding the claims" shall be transferred to petitioner. As pointed out by the Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine’s assets upon dissolution of the parties’ business relations. There was nothing in the agreement that would require Baguio Gold to make payments of the advances to petitioner as would be recognized as an item of obligation or "accounts payable" for Baguio Gold.

Thus, the tax court correctly concluded that the agreement provided for a distribution of assets of the Sto. Niño mine upon termination, a provision that is more consistent with a partnership than a creditor-debtor relationship. It should be pointed out that in a contract of loan, a person who receives a loan or money or any fungible thing acquires ownership thereof and is bound to pay the creditor an equal amount of the same kind and quality. In this case, however, there was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it had advanced, but only the return of an amount pegged at a ratio which the manager’s account had to the owner’s account.

In this connection, we find no contractual basis for the execution of the two compromise agreements in which Baguio Gold recognized a debt in favor of petitioner, which supposedly arose from the termination of their business relations over the Sto. Nino mine. The "Power of Attorney" clearly provides that petitioner would only be entitled to the return of a proportionate share of the mine assets to be computed at a ratio that the manager’s account had to the owner’s account. Except to provide a basis for claiming the advances as a bad debt deduction, there is no reason for Baguio Gold to hold itself liable to petitioner under the compromise agreements, for any amount over and above the proportion agreed upon in the "Power of Attorney".

Next, the tax court correctly observed that it was unlikely for a business corporation to lend hundreds of millions of pesos to another corporation with neither security, or collateral, nor a specific deed evidencing the terms and conditions of such loans. The parties also did not provide a specific maturity date for the advances to become due and demandable, and the manner of payment was unclear. All these point to the inevitable conclusion that the advances were not loans but capital contributions to a partnership.

The strongest indication that petitioner was a partner in the Sto Niño mine is the fact that it would receive 50% of the net profits as "compensation" under paragraph 12 of the agreement. The entirety of the parties’ contractual stipulations simply leads to no other conclusion than that petitioner’s "compensation" is actually its share in the income of the joint venture.

Article 1769 (4) of the Civil Code explicitly provides that the "receipt by a person of a share in the profits of a business is prima facie evidence that he is a partner in the business." Petitioner asserts, however, that no such inference can be drawn against it since its share in the profits of the Sto Niño project was in the nature of compensation or "wages of an employee", under the exception provided in Article 1769 (4) (b).

On this score, the tax court correctly noted that petitioner was not an employee of Baguio Gold who will be paid "wages" pursuant to an employer-employee relationship. To begin with, petitioner was the manager of the project and had put substantial sums into the venture in order to ensure its viability and profitability. By pegging its compensation to profits, petitioner also stood not to be remunerated in case the mine had no income. It is hard to believe that petitioner would take the risk of not being paid at all for its services, if it were truly just an ordinary employee.

Consequently, we find that petitioner’s "compensation" under paragraph 12 of the agreement actually constitutes its share in the net profits of the partnership. Indeed, petitioner would not be entitled to an equal share in the income of the mine if it were just an employee of Baguio Gold. It is not surprising that petitioner was to receive a 50% share in the net profits, considering that the "Power of Attorney" also provided for an almost equal contribution of the parties to the St. Nino mine. The "compensation" agreed upon only serves to reinforce the notion that the parties’ relations were indeed of partners and not employer-employee.

All told, the lower courts did not err in treating petitioner’s advances as investments in a partnership known as the Sto. Nino mine. The advances were not "debts" of Baguio Gold to petitioner inasmuch as the latter was under no unconditional obligation to return the same to the former under the "Power of Attorney". As for the amounts that petitioner paid as guarantor to Baguio Gold’s creditors, we find no reason to depart from the tax court’s factual finding that Baguio Gold’s debts were not yet due and demandable at the time that petitioner paid the same. Verily, petitioner pre-paid Baguio Gold’s outstanding loans to its bank creditors and this conclusion is supported by the evidence on record. In sum, petitioner cannot claim the advances as a bad debt deduction from its gross income. Deductions for income tax purposes partake of the nature of tax exemptions and are strictly construed against the taxpayer, who must prove by convincing evidence that he is entitled to the deduction claimed.27 In this case, petitioner failed to substantiate its assertion that the advances were subsisting debts of Baguio Gold that could be deducted from its gross income. Consequently, it could not claim the advances as a valid bad debt deduction.

WHEREFORE, the petition is DENIED. The decision of the Court of Appeals in CA-G.R. SP No. 49385 dated June 30, 2000, which affirmed the decision of the Court of Tax Appeals in C.T.A. Case No. 5200 is AFFIRMED. Petitioner Philex Mining Corporation is ORDERED to PAY the deficiency tax on its 1982 income in the amount of P62,811,161.31, with 20% delinquency interest computed from February 10, 1995, which is the due date given for the payment of the deficiency income tax, up to the actual date of payment.

SO ORDERED.

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.ITOGON-SUYOC MINES, INC., and THE COURT OF TAX APPEALS, respondents.

Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and Special Attorney Oscar S. de Castro for petitioner.Ramon O. Reynoso, Jr. and Melchor R. Flores for respondents.

FERNANDO, J.:

The question presented for determination in this petition for the review of a decision of the Court of Tax Appeals, one that is of first impression, would not have arisen had respondent Itogon-Suyoc Mines, Inc., the taxpayer involved, duly paid in full its liability according to its income tax return for the fiscal year 1960-61. Instead, it deducted right away the amount represented by claim for refund filed eight (8) months back, for the previous year's income tax, for which it was not liable at all, so it alleged, as it suffered a loss instead, a claim subsequently favorably acted on by petitioner Commissioner of Internal Revenue but after the date of such payment of the 1960-1961 tax. Accordingly, an interest in the amount of P1,512.83 was charged by petitioner Commissioner of Internal Revenue on the sum withheld on the ground that no deduction on such refund should be allowed before its approval. When the matter was taken up before the Court of Tax Appeals, the above assessment representing interest was set aside in the decision of September 30, 1965. That is the decision now an appeal by petitioner Commissioner of Internal Revenue. We sustain the Court of Tax Appeals.

Respondent Itogon-Suyoc Mines, Inc., a mining corporation duly organized and existing in accordance with the laws of the Philippines, filed on January 13, 1961, its income tax return for the fiscal year 1959-1960. It declared a taxable income of P114,368.04 and a tax due thereon amounting to P26,310.41, for which it paid on the same day, the amount of P13,155.20 as the first installment of the income tax due. On May 17, 1961, petitioner filed an amended income tax return, reporting therein a net loss of P331,707.33. It thus sought a refund from the Commissioner of Internal Revenue, now the petitioner. 1äwphï1.ñët

On February 14, 1962, respondent Itogon-Suyoc Mines, Inc. filed its income tax return for the fiscal year 1960-1961, setting forth its income tax liability to the tune of P97,345.00, but deducting the amount of P13,155.20 representing alleged tax credit for overpayment of the preceding fiscal year 1959-1960. 0n December 18, 1962, petitioner Commissioner of Internal Revenue assessed against the respondent the amount of P1,512.83 as 1% monthly interest on the aforesaid amount of P13,155.20 from January 16, 1962 to December 31, 1962. The basis for such an assessment was the absence of legal right to deduct said amount before the refund or tax credit thereof was approved by petitioner Commissioner of Internal Revenue. 1

Such an assessment was contested by respondent before the Court of Tax Appeals. As already noted, it prevailed. The decision of September 30, 1965, now on appeal, explains why. Thus: "Respondent assessed against the petitioner the amount of P1,512.83 as 1% monthly interest on the sum of P13,155.20 from January 16, 1962 to December 31, 1962 on the ground that petitioner had

no legal right to deduct the said amount from its income tax liability for the fiscal year 1960-1961 until the refund or tax credit thereof has been approved by respondent. As aforestated, petitioner paid the amount of P13,155.20 as first installment on its reported income tax liability for the fiscal year 1959-1960. But, it turned out that instead of deriving a net gain, it sustained a net loss during the said fiscal year. Accordingly, it filed an amended income tax return and a claim for the refund of the sum of P13,155.20, which sum it subsequently, deducted from its income tax liability for the succeeding fiscal year 1960-1961. The overpayment for the fiscal year 1959-1960 and the deduction of the overpaid amount from its 1960-1961 tax liability are not denied by respondent. In this circumstance, we find it unfair and unjust for the Commissioner to exact an interest on the said sum of P13,155.20, which, after all, was paid to and received by the government even before the incidence of the tax in question." 2

That is the question before us in this petition for review by the Commissioner of Internal Revenue. He argues that the Court of Tax Appeals should not have absolved respondent corporation "from liability to pay the sum of P1,512.83 as 1% monthly interest for delinquency in the payment of income tax for the fiscal year 1960-1961." 3As noted at the outset, we find such contention far from persuasive.

It could not be error for the Court of Tax Appeals, considering the admitted fact of overpayment, entitling respondent to refund, to hold that petitioner should not repose an interest on the aforesaid sum of P13,155.20 "which after all was paid to and received by the government even before the incidence of the tax in question." It would be, according to the Court of Tax Appeals, "unfair and unjust" to do so. We agree but we go farther. The imposition of such an interest by petitioner is not supported by law.

The National Internal Revenue Code provides that interest upon the amount determined as a deficiency shall be assessed and shall be paid upon notice and demand from the Commissioner of Internal Revenue at the specified.4 It is made clear, however, in an earlier provision found in the same section that if in any preceding year, the taxpayer was entitled to a refund of any amount due as tax, such amount, if not yet refunded, may be deducted from the tax to be paid. 5

There is no question respondent was entitled to a refund. Instead of waiting for the sum involved to be delivered to it, it deducted the said amount from the tax that it had to pay. That it had a right to do according to the law. It is true a doubt could have arisen due to the fact that as of the time such a deduction was made, the Commissioner of Internal Revenue had not as yet approved such a refund. It is an admitted fact though that respondent was clearly entitled to it, and petitioner did not allege otherwise. Nor could he do so. Under all the circumstances disclosed therefore, the applicability of the legal provision allowing such a deduction from the amount of the tax to be paid cannot be disputed.

This conclusion is in accordance with the principle announced in Castro v. Collector of Internal Revenue. 6 While the case is not directly in point, it yields an implication that makes even more formidable the case for respondent taxpayer. As there held, the imposition of the monthly interest was considered as not constituting a penalty "but a just compensation to the state for the delay in paying the tax, and for the concomitant use by the taxpayer of funds that rightfully should be in the government's hands ...."

What is therefore sought to be avoided is for the taxpayer to make use of funds that should have been paid to the government. Here, in view of the overpayment for the fiscal year 1959-1960, the sum of P13,155.20 had already formed part of the public funds. It cannot be said, therefore, that respondent taxpayer was guilty of any delay enabling it to utilize a sum of money that should have been in the government treasury.

How then, as a matter of pure law, even if we lay to one side the demands of fairness and justice, which to the Court of Tax Appeals seem to be uppermost, can its decision be overturned? Accordingly, we find no valid ground for this appeal.

WHEREFORE, the decision of September 30, 1965 of the Court of Tax Appeals is affirmed. Without pronouncement as to costs.1äwphï1.ñët

G.R. Nos. 106949-50 December 1, 1995

PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES (PICOP), petitioner, vs.COURT OF APPEALS, COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS,respondents.

G.R. Nos. 106984-85 December 1, 1995

COMMISSIONER INTERNAL REVENUE, petitioner, vs.PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES, THE COURT OF APPEALS and THE COURT OF TAX APPEALS, respondents.

 

FELICIANO, J.:

The Paper Industries Corporation of the Philippines ("Picop"), which is petitioner in G.R. Nos. 106949-50 and private respondent in G.R. Nos. 106984-85, is a Philippine corporation registered with the Board of Investments ("BOI") as a preferred pioneer enterprise with respect to its integrated pulp and paper mill, and as a preferrednon-pioneer enterprise with respect to its integrated plywood and veneer mills.

On 21 April 1983, Picop received from the Commissioner of Internal Revenue ("CIR") two (2) letters of assessment and demand both dated 31 March 1983: (a) one for deficiency transaction tax and for documentary and science stamp tax; and (b) the other for deficiency income tax for 1977, for an aggregate amount ofP88,763,255.00. These assessments were computed as follows:

Transaction Tax

Interest payments on

money market

borrowings P 45,771,849.00———————

35% Transaction tax due

thereon 16,020,147.00

Add: 25% surcharge 4,005,036.75

——————

T o t a l P 20,025,183.75

Add:

14% int. fr.

1-20-78 to

7-31-80 P 7,093,302.57

20% int, fr.

8-1-80 to

3-31-83 10,675,523.58

——————

17,768,826.15

——————

P 37,794,009.90

Documentary and Science Stamps Tax

Total face value of

debentures P100,000,000.00

Documentary Stamps

Tax Due

(P0.30 x P100,000.000 )

( P200 ) P 150,000.00

Science Stamps Tax Due

(P0.30 x P100,000,000 )

( P200 ) P 150,000.00

——————

T o t a l P 300,000.00

Add: Compromise for

non-affixture 300.00

——————

300,300.00

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 38,094,309.90

===========

Deficiency Income Tax for 1977

Net income per return P 258,166.00

Add: Unallowable deductions

1) Disallowed deductions

availed of under

R.A. No. 5186 P 44,332,980.00

2) Capitalized interest

expenses on funds

used for acquisition

of machinery & other

equipment 42,840,131.00

3) Unexplained financial

guarantee expense 1,237,421.00

4) Understatement

of sales 2,391,644.00

5) Overstatement of

cost of sales 604,018.00

——————

P91,406,194.00

Net income per investigation P91,664,360.00

Income tax due thereon 34,734,559.00

Less: Tax already assessed per return 80,358.00

——————

Deficiency P34,654,201.00

Add:

14% int. fr.

4-15-78 to

7-31-81 P 11,128,503.56

20% int. fr.

8-1-80 to

4-15-81 4,886,242.34

——————

P16,014,745.90

——————

TOTAL AMOUNT DUE AND COLLECTIBLE P 50,668,946.90 1

===========

On 26 April 1983, Picop protested the assessment of deficiency transaction tax and documentary and science stamp taxes. Picop also protested on 21 May 1983 the deficiency income tax assessment for 1977. These protests were not formally acted upon by respondent CIR. On 26 September 1984, the CIR issued a warrant of distraint on personal property and a warrant of levy on real property against Picop, to enforce collection of the contested assessments; in effect, the CIR denied Picop's protests.

Thereupon, Picop went before the Court of Tax Appeals ("CTA") appealing the assessments. After trial, the CTA rendered a decision dated 15 August 1989, modifying the findings of the CIR and holding Picop liable for the reduced aggregate amount of P20,133,762.33, which was itemized in the dispositive portion of the decision as follows:

35% Transaction Tax P 16,020,113.20

Documentary & Science

Stamp Tax 300,300.00

Deficiency Income Tax Due 3,813,349.33

——————

TOTAL AMOUNT DUE AND PAYABLE P 20,133,762.53 2

===========

Picop and the CIR both went to the Supreme Court on separate Petitions for Review of the above decision of the CTA. In two (2) Resolutions dated 7 February 1990 and 19 February 1990, respectively, the Court referred the two (2) Petitions to the Court of Appeals. The Court of Appeals consolidated the two (2) cases and rendered a decision, dated 31 August 1992, which further reduced the liability of Picop to P6,338,354.70. The dispositive portion of the Court of Appeals decision reads as follows:

WHEREFORE, the appeal of the Commissioner of Internal Revenue is denied for lack of merit. The judgment against PICOP is modified, as follows:

1. PICOP is declared liable for the 35% transaction tax in the amount of P3,578,543.51;

2. PICOP is absolved from the payment of documentary and science stamp tax of P300,000.00 and the compromise penalty of P300.00;

3. PICOP shall pay 20% interest per annum on the deficiency income tax of P1,481,579.15, for a period of three (3) years from 21 May 1983, or in the total amount of P888,947.49, and a surcharge of 10% on the latter amount, or P88,984.75.

No pronouncement as to costs.

SO ORDERED.

Picop and the CIR once more filed separate Petitions for Review before the Supreme Court. These cases were consolidated and, on 23 August 1993, the Court resolved to give due course to both Petitions in G.R. Nos. 106949-50 and 106984-85 and required the parties to file their Memoranda.

Picop now maintains that it is not liable at all to pay any of the assessments or any part thereof. It assails the propriety of the thirty-five percent (35%) deficiency transaction tax which the Court of Appeals held due from it in the amount of P3,578,543.51. Picop also questions the imposition by the Court of Appeals of the deficiency income tax of P1,481,579.15, resulting from disallowance of certain claimed financial guarantee expenses and claimed year-end adjustments of sales and cost of sales figures by Picop's external auditors. 3

The CIR, upon the other hand, insists that the Court of Appeals erred in finding Picop not liable for surcharge and interest on unpaid transaction tax and for documentary and science stamp taxes and in allowing Picop to claim as deductible expenses:

(a) the net operating losses of another corporation (i.e., Rustan Pulp and Paper Mills, Inc.); and

(b) interest payments on loans for the purchase of machinery and equipment.

The CIR also claims that Picop should be held liable for interest at fourteen percent (14%) per annum from 15 April 1978 for three (3) years, and interest at twenty percent (20%) per annum for a maximum of three (3) years; and for a surcharge of ten percent (10%), on Picop's deficiency income tax. Finally, the CIR contends that Picop is liable for the corporate development tax equivalent to five percent (5%) of its correct 1977 net income.

The issues which we must here address may be sorted out and grouped in the following manner:

I. Whether Picop is liable for:

(1) the thirty-five percent (35%) transaction tax;

(2) interest and surcharge on unpaid transaction tax; and

(3) documentary and science stamp taxes;

II. Whether Picop is entitled to deductions against income of:

(1) interest payments on loans for the purchase of machinery and equipment;

(2) net operating losses incurred by the Rustan Pulp and Paper Mills, Inc.; and

(3) certain claimed financial guarantee expenses; and

III. (1) Whether Picop had understated its sales and overstated its cost of sales for 1977; and

(2) Whether Picop is liable for the corporate development tax of five percent (5%) of its net income for 1977.

We will consider these issues in the foregoing sequence.

I.

(1) Whether Picop is liablefor the thirty-five percent(35%) transaction tax.

With the authorization of the Securities and Exchange Commission, Picop issued commercial paper consisting of serially numbered promissory notes with the total face value of P229,864,000.00 and a maturity period of one (1) year, i.e., from 24 December 1977 to 23 December 1978. These promissory notes were purchased by various commercial banks and financial institutions. On these

promissory notes, Picop paid interest in the aggregate amount of P45,771,849.00. In respect of these interest payments, the CIR required Picop to pay the thirty-five percent (35%) transaction tax.

The CIR based this assessment on Presidential Decree No. 1154 dated 3 June 1977, which reads in part as follows:

Sec. 1. The National Internal Revenue Code, as amended, is hereby further amended by adding a new section thereto to read as follows:

Sec. 195-C. Tax on certain interest. — There shall be levied, assessed, collected and paid on every commercial paper issued in the primary market as principal instrument, a transaction tax equivalent to thirty-five percent (35%) based on the gross amount of interest thereto as defined hereunder, which shall be paid by the borrower/issuer: Provided, however, that in the case of a long-term commercial paper whose maturity exceeds more than one year, the borrower shall pay the tax based on the amount of interest corresponding to one year, and thereafter shall pay the tax upon accrual or actual payment (whichever is earlier) of the untaxed portion of the interest which corresponds to a period not exceeding one year.

The transaction tax imposed in this section shall be a final tax to be paid by the borrower and shall be allowed as a deductible item for purposes of computing the borrower's taxable income.

For purposes of this tax —

(a) "Commercial paper" shall be defined as an instrument evidencing indebtedness of any person or entity, including banks and non-banks performing quasi-banking functions, which is issued, endorsed, sold, transferred or in any manner conveyed to another person or entity, either with or without recourse and irrespective of maturity. Principally, commercial papers are promissory notesand/or similar instruments issued in the primary market and shall not include repurchase agreements, certificates of assignments, certificates of participations, and such other debt instruments issued in the secondary market.

(b) The term "interest" shall mean the difference between what the principal borrower received and the amount it paid upon maturity of the commercial paper which shall, in no case, be lower than the interest rate prevailing at the time of the issuance or renewal of the commercial paper. Interest shall be deemed synonymous with discount and shall include all fees, commissions, premiums and other payments which form integral parts of the charges imposed as a consequence of the use of money.

In all cases, where no interest rate is stated or if the rate stated is lower than the prevailing interest rate at the time of the issuance or renewal of commercial paper, the Commissioner of Internal Revenue, upon consultation with the Monetary Board of the Central Bank of the Philippines, shall adjust the interest rate in accordance herewith, and assess the tax on the basis thereof.

The tax herein imposed shall be remitted by the borrower to the Commissioner of Internal Revenue or his Collection Agent in the municipality where such borrower has its principal place of business within five (5) working days from the issuance of the commercial paper. In the case of long term commercial paper, the tax upon the

untaxed portion of the interest which corresponds to a period not exceeding one year shall be paid upon accrual payment, whichever is earlier. (Emphasis supplied)

Both the CTA and the Court of Appeals sustained the assessment of transaction tax.

In the instant Petition, Picop reiterates its claim that it is exempt from the payment of the transaction tax by virtue of its tax exemption under R.A. No. 5186, as amended, known as the Investment Incentives Act, which in the form it existed in 1977-1978, read in relevant part as follows:

Sec. 8. Incentives to a Pioneer Enterprise. In addition to the incentives provided in the preceding section, pioneer enterprises shall be granted the following incentive benefits:

(a) Tax Exemption. Exemption from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent:

(1) One hundred per cent (100%) for the first five years;

(2) Seventy-five per cent (75%) for the sixth through the eighth years;

(3) Fifty per cent (50%) for the ninth and tenth years;

(4) Twenty per cent (20%) for the eleventh and twelfth years; and

(5) Ten per cent (10%) for the thirteenth through the fifteenth year.

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We agree with the CTA and the Court of Appeals that Picop's tax exemption under R.A. No. 5186, as amended, does not include exemption from the thirty-five percent (35%) transaction tax. In the first place, the thirty-five percent (35%) transaction tax 5 is an income tax, that is, it is a tax on the interest income of the lenders or creditors. InWestern Minolco Corporation v. Commissioner of Internal Revenue, 6 the petitioner corporation borrowed funds from several financial institutions from June 1977 to October 1977 and paid the corresponding thirty-five (35%) transaction tax thereon in the amount of P1,317,801.03, pursuant to Section 210 (b) of the 1977 Tax Code. Western Minolco applied for refund of that amount alleging it was exempt from the thirty-five (35%) transaction tax by reason of Section 79-A of C.A. No. 137, as amended, which granted new mines and old mines resuming operation "five (5) years complete tax exemptions, except income tax, from the time of its actual bonafide orders for equipment for commercial production." In denying the claim for refund, this Court held:

The petitioner's contentions deserve scant consideration. The 35% transaction tax is imposed on interest income from commercial papers issued in the primary money market. Being a tax on interest, it is a tax on income.

As correctly ruled by the respondent Court of Tax Appeals:

Accordingly, we need not and do not think it necessary to discuss further the nature of the transaction tax more than to say that the incipient scheme in the issuance of Letter of Instructions No. 340 on November 24, 1975 (O.G. Dec. 15, 1975), i.e., to achieve operational

simplicity and effective administration in capturing the interest-income "windfall" from money market operations as a new source of revenue, has lost none of its animating principle in parturition of amendatory Presidential Decree No. 1154, now Section 210 (b) of the Tax Code. The tax thus imposed is actually a tax on interest earnings of the lenders or placers who are actually the taxpayers in whose income is imposed. Thus "the borrower withholds the tax of 35% from the interest he would have to pay the lender so that he (borrower) can pay the 35% of the interest to the Government." (Citation omitted) . . . . Suffice it to state that the broad consensus of fiscal and monetary authorities is that "even if nominally, the borrower is made to pay the tax, actually, the tax is on the interest earning of the immediate and all prior lenders/placers of the money. . . ." (Rollo, pp. 36-37)

The 35% transaction tax is an income tax on interest earnings to the lenders or placers. The latter are actually the taxpayers. Therefore, the tax cannot be a tax imposed upon the petitioner. In other words, the petitioner who borrowed funds from several financial institutions by issuing commercial papers merely withheld the 35% transaction tax before paying to the financial institutions the interests earned by them and later remitted the same to the respondent Commissioner of Internal Revenue. The tax could have been collected by a different procedure but the statute chose this method. Whatever collecting procedure is adopted does not change the nature of the tax.

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(Emphasis supplied)

Much the same issue was passed upon in Marinduque Mining Industrial Corporation v. Commissioner of Internal Revenue 8 and resolved in the same way:

It is very obvious that the transaction tax, which is a tax on interest derived from commercial paper issued in the money market, is not a tax contemplated in the above-quoted legal provisions. The petitioner admits that it is subject to income tax. Its tax exemption should be strictly construed.

We hold that petitioner's claim for refund was justifiably denied. The transaction tax, although nominally categorized as a business tax, is in reality a withholding tax as positively stated in LOI No. 340. The petitioner could have shifted the tax to the lenders or recipients of the interest. It did not choose to do so. It cannot be heard now to complain about the tax. LOI No. 340 is an extraneous or extrinsic aid to the construction of section 210 (b).

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(Emphasis supplied)

It is thus clear that the transaction tax is an income tax and as such, in any event, falls outside the scope of the tax exemption granted to registered pioneer enterprises by Section 8 of R.A. No. 5186, as amended. Picop was the withholding agent, obliged to withhold thirty-five percent (35%) of the interest payable to its lenders and to remit the amounts so withheld to the Bureau of Internal

Revenue ("BIR"). As a withholding agent, Picop is madepersonally liable for the thirty-five percent (35%) transaction tax 10 and if it did not actually withhold thirty-five percent (35%) of the interest monies it had paid to its lenders, Picop had only itself to blame.

Picop claims that it had relied on a ruling, dated 6 October 1977, issued by the CIR, which held that Picop was not liable for the thirty-five (35%) transaction tax in respect of debenture bonds issued by Picop. Prior to the issuance of the promissory notes involved in the instant case, Picop had also issued debenture bonds P100,000,000.00 in aggregate face value. The managing underwriter of this debenture bond issue, Bancom Development Corporation, requested a formal ruling from the Bureau of Internal Revenue on the liability of Picop for the thirty-five percent (35%) transaction tax in respect of such bonds. The ruling rendered by the then Acting Commissioner of Internal Revenue, Efren I. Plana, stated in relevant part:

It is represented that PICOP will be offering to the public primary bonds in the aggregate principal sum of one hundred million pesos (P100,000,000.00); that the bonds will be issued as debentures in denominations of one thousand pesos (P1,000.00) or multiples, to mature in ten (10) years at 14% interest per annum payable semi-annually; that the bonds are convertible into common stock of the issuer at the option of the bond holder at an agreed conversion price; that the issue will be covered by a "Trust Indenture" with a duly authorized trust corporation as required by the Securities and Exchange Commission, which trustee will act for and in behalf of the debenture bond holders as beneficiaries; that once issued, the bonds cannot be preterminated by the holder and cannot be redeemed by the issuer until after eight (8) years from date of issue; that the debenture bonds will besubordinated to present and future debts of PICOP; and that said bonds are intended to be listed in the stock exchanges, which will place them alongside listed equity issues.

In reply, I have the honor to inform you that although the bonds hereinabove described are commercial papers which will be issued in the primary market, however, it is clear from the abovestated facts that said bonds will not be issued as money market instruments. Such being the case, and considering that the purposes of Presidential Decree No. 1154, as can be gleaned from Letter of Instruction No. 340, dated November 21, 1975, are (a) to regulate money market transactions and (b) to ensure the collection of the tax on interest derived from money market transactions by imposing a withholding tax thereon, said bonds do not come within the purview of the"commercial papers" intended to be subjected to the 35% transaction tax prescribed in Presidential Decree No. 1154, as implemented by Revenue Regulations No. 7-77. (See Section 2 of said Regulation) Accordingly, PICOP is not subject to 35% transaction tax on its issues of the aforesaid bonds. However, those investing in said bonds should be made aware of the fact that the transaction tax is not being imposed on the issuer of said bonds by printing or stamping thereon, in bold letters, the following statement: "ISSUER NOT SUBJECT TO TRANSACTION TAX UNDER P.D. 1154. BONDHOLDER SHOULD DECLARE INTEREST EARNING FOR INCOME TAX." 11 (Emphases supplied)

In the above quoted ruling, the CIR basically held that Picop's debenture bonds did not constitute "commercial papers" within the meaning of P.D. No. 1154, and that, as such, those bonds were not subject to the thirty-five percent (35%) transaction tax imposed by P.D. No. 1154.

The above ruling, however, is not applicable in respect of the promissory notes which are the subject matter of the instant case. It must be noted that the debenture bonds which were the subject matter

of Commissioner Plana's ruling were long-term bonds maturing in ten (10) years and which could not be pre-terminated and could not be redeemed by Picop until after eight (8) years from date of issue; the bonds were moreover subordinated to present and future debts of Picop and convertible into common stock of Picop at the option of the bondholder. In contrast, the promissory notes involved in the instant case are short-term instruments bearing a one-year maturity period. These promissory notes constitute the very archtype of money market instruments. For money market instruments are precisely, by custom and usage of the financial markets, short-term instruments with a tenor of one (1) year or less. 12 Assuming, therefore, (without passing upon) the correctness of the 6 October 1977 BIR ruling, Picop's short-term promissory notes must be distinguished, and treated differently, from Picop's long-term debenture bonds.

We conclude that Picop was properly held liable for the thirty-five percent (35%) transaction tax due in respect of interest payments on its money market borrowings.

At the same time, we agree with the Court of Appeals that the transaction tax may be levied only in respect of the interest earnings of Picop's money market lenders accruing after P.D. No. 1154 went into effect, and not in respect of all the 1977 interest earnings of such lenders. The Court of Appeals pointed out that:

PICOP, however contends that even if the tax has to be paid, it should be imposed only for the interests earned after 20 September 1977 when PD 1154 creating the tax became effective. We find merit in this contention. It appears that the tax was levied on interest earnings from January to October, 1977. However, as found by the lower court, PD 1154 was published in the Official Gazette only on 5 September 1977, and became effective only fifteen (15) days after the publication, or on 20 September 1977, no other effectivity date having been provided by the PD. Based on the Worksheet prepared by the Commissioner's office, the interests earned from 20 September to October 1977 was P10,224,410.03. Thirty-five (35%) per cent of this is P3,578,543.51 which is all PICOP should pay as transaction tax. 13 (Emphasis supplied)

P.D. No. 1154 is not, in other words, to be given retroactive effect by imposing the thirty-five percent (35%) transaction tax in respect of interest earnings which accrued before the effectivity date of P.D. No. 1154, there being nothing in the statute to suggest that the legislative authority intended to bring about such retroactive imposition of the tax.

(2) Whether Picop is liablefor interest and surchargeon unpaid transaction tax.

With respect to the transaction tax due, the CIR prays that Picop be held liable for a twenty-five percent (25%) surcharge and for interest at the rate of fourteen percent (14%) per annum from the date prescribed for its payment. In so praying, the CIR relies upon Section 10 of Revenue Regulation 7-77 dated 3 June 1977, 14 issued by the Secretary of Finance. This Section reads:

Sec. 10. Penalties. — Where the amount shown by the taxpayer to be due on its return or part of such payment is not paid on or before the date prescribed for its payment, the amount of the tax shall be increased by twenty-five (25%) per centum, the increment to be a part of the tax and theentire amount shall be subject to interest at the rate of fourteen (14%) per centum per annum from the date prescribed for its payment.

In the case of willful neglect to file the return within the period prescribed herein or in case a false or fraudulent return is willfully made, there shall be added to the tax or to the deficiency tax in case any payment has been made on the basis of such return before the discovery of the falsity or fraud, asurcharge of fifty (50%) per centum of its amount. The amount so added to any tax shall be collected at the same time and in the same manner and as part of the tax unless the tax has been paid before the discovery of the falsity or fraud, in which case the amount so added shall be collected in the same manner as the tax.

In addition to the above administrative penalties, the criminal and civil penalties as provided for under Section 337 of the Tax Code of 1977 shall be imposed for violation of any provision of Presidential Decree No. 1154. 15 (Emphases supplied)

The 1977 Tax Code itself, in Section 326 in relation to Section 4 of the same Code, invoked by the Secretary of Finance in issuing Revenue Regulation 7-77, set out, in comprehensive terms, the rule-making authority of the Secretary of Finance:

Sec. 326. Authority of Secretary of Finance to Promulgate Rules and Regulations. — The Secretary of Finance, upon recommendation of the Commissioner of Internal Revenue, shall promulgate all needful rules and regulations for the effective enforcement of the provisions of this Code. (Emphasis supplied)

Section 4 of the same Code contains a list of subjects or areas to be dealt with by the Secretary of Finance through the medium of an exercise of his quasi-legislative or rule-making authority. This list, however, while it purports to be open-ended, does not include the imposition of administrative or civil penalties such as the payment of amounts additional to the tax due. Thus, in order that it may be held to be legally effective in respect of Picop in the present case, Section 10 of Revenue Regulation 7-77 must embody or rest upon some provision in the Tax Code itself which imposes surcharge and penalty interest for failure to make a transaction tax payment when due.

P.D. No. 1154 did not itself impose, nor did it expressly authorize the imposition of, a surcharge and penalty interest in case of failure to pay the thirty-five percent (35%) transaction tax when due. Neither did Section 210 (b) of the 1977 Tax Code which re-enacted Section 195-C inserted into the Tax Code by P.D. No. 1154.

The CIR, both in its petition before the Court of Appeals and its Petition in the instant case, points to Section 51 (e) of the 1977 Tax Code as its source of authority for assessing a surcharge and penalty interest in respect of the thirty-five percent (35%) transaction tax due from Picop. This Section needs to be quoted in extenso:

Sec. 51. Payment and Assessment of Income Tax. —

(c) Definition of deficiency. — As used in this Chapter in respect of a tax imposed by this Title, the term "deficiency" means:

(1) The amount by which the tax imposed by this Title exceeds the amount shown as the tax by the taxpayer upon his return; but the amount so shown on the return shall first be increased by the amounts previously assessed (or collected without assessment) as a deficiency, and decreased by the amount previously abated, credited, returned, or otherwise in respect of such tax; . . .

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(e) Additions to the tax in case of non-payment. —

(1) Tax shown on the return. — Where the amount determined by the taxpayer as the tax imposed by this Title or any installment thereof, or any part of such amount or installment is not paid on or before the date prescribed for its payment, there shall be collected as a part of the tax, interest upon such unpaid amount at the rate of fourteen per centum per annum from the date prescribed for its payment until it is paid: Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding.

(2) Deficiency. — Where a deficiency, or any interest assessed in connection therewith under paragraph (d) of this section, or any addition to the taxes provided for in Section seventy-two of this Code is not paid in full within thirty days from the date of notice and demand from the Commissioner of Internal Revenue, there shall be collected upon the unpaid amount as part of the tax, interest at the rate of fourteen per centum per annum from the date of such notice and demand until it is paid:Provided, That the maximum amount that may be collected as interest on deficiency shall in no case exceed the amount corresponding to a period of three years, the present provisions regarding prescription to the contrary notwithstanding.

(3) Surcharge. — If any amount of tax included in the notice and demand from the Commissioner of Internal Revenue is not paid in full within thirty days after such notice and demand, there shall be collected in addition to the interest prescribed herein and in paragraph (d) above and as part of the tax a surcharge of five per centum of the amount of tax unpaid. (Emphases supplied)

Section 72 of the 1977 Tax Code referred to in Section 51 (e) (2) above, provides:

Sec. 72. Surcharges for failure to render returns and for rendering false and fraudulent returns. — In case of willful neglect to file the return or list required by this Title within the time prescribed by law, or in case a false or fraudulent return or list is wilfully made, the Commissioner of Internal Revenue shall add to the tax or to the deficiency tax, in case any payment has been made on the basis of such return before the discovery of the falsity or fraud, as surcharge of fifty per centum of the amount of such tax or deficiency tax. In case of any failure to make and file a return or list within the time prescribed by law or by the Commissioner or other Internal Revenue Officer, not due to willful neglect, the Commissioner of Internal Revenue shall add to the tax twenty-five per centum of its amount, except that, when a return is voluntarily and without notice from the Commissioner or other officer filed after such time, and it is shown that the failure to file it was due to a reasonable cause, no such addition shall be made to the tax. The amount so added to any tax shall be collected at the same time, in the same manner and as part of the tax unless the tax has been paid before the discovery of the neglect, falsity, or fraud, in which case the amount so added shall be collected in the same manner as the tax. (Emphases supplied)

It will be seen that Section 51 (c) (1) and (e) (1) and (3), of the 1977 Tax Code, authorize the imposition of surcharge and interest only in respect of a "tax imposed by this Title," that is to say, Title II on "Income Tax." It will also be seen that Section 72 of the 1977 Tax Code imposes a

surcharge only in case of failure to file a return or list "required by this Title," that is, Title II on "Income Tax." The thirty-five percent (35%) transaction tax is, however, imposed in the 1977 Tax Code by Section 210 (b) thereof which Section is embraced in Title V on"Taxes on Business" of that Code. Thus, while the thirty-five percent (35%) transaction tax is in truth a tax imposed on interest income earned by lenders or creditors purchasing commercial paper on the money market, the relevant provisions, i.e., Section 210 (b), were not inserted in Title II of the 1977 Tax Code. The end result is that the thirty-five percent (35%) transaction tax is not one of the taxes in respect of which Section 51 (e) authorized the imposition of surcharge and interest and Section 72 the imposition of a fraud surcharge.

It is not without reluctance that we reach the above conclusion on the basis of what may well have been an inadvertent error in legislative draftsmanship, a type of error common enough during the period of Martial Law in our country. Nevertheless, we are compelled to adopt this conclusion. We consider that the authority to impose what the present Tax Code calls (in Section 248) civil penalties consisting of additions to the tax due, must be expressly given in the enabling statute, in language too clear to be mistaken. The grant of that authority is not lightly to be assumed to have been made to administrative officials, even to one as highly placed as the Secretary of Finance.

The state of the present law tends to reinforce our conclusion that Section 51 (c) and (e) of the 1977 Tax Code did not authorize the imposition of a surcharge and penalty interest for failure to pay the thirty-five percent (35%) transaction tax imposed under Section 210 (b) of the same Code. The corresponding provision in the current Tax Code very clearly embraces failure to pay all taxes imposed in the Tax Code, without any regard to the Title of the Code where provisions imposing particular taxes are textually located. Section 247 (a) of the NIRC, as amended, reads:

Title X

Statutory Offenses and Penalties

Chapter I

Additions to the Tax

Sec. 247. General Provisions. — (a) The additions to the tax or deficiency tax prescribed in this Chapter shall apply to all taxes, fees and charges imposed in this Code. The amount so added to the tax shall be collected at the same time, in the same manner and as part of the tax. . . .

Sec. 248. Civil Penalties. — (a) There shall be imposed, in addition to the tax required to be paid, penalty equivalent to twenty-five percent (25%) of the amount due, in the following cases:

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(3) failure to pay the tax within the time prescribed for its payment; or

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(c) the penalties imposed hereunder shall form part of the tax and the entire amount shall be subject to the interest prescribed in Section 249.

Sec. 249. Interest. — (a) In General. — There shall be assessed and collected on any unpaid amount of tax, interest at the rate of twenty percent (20%) per annum or such higher rate as may be prescribed by regulations, from the date prescribed for payment until the amount is fully paid. . . . (Emphases supplied)

In other words, Section 247 (a) of the current NIRC supplies what did not exist back in 1977 when Picop's liability for the thirty-five percent (35%) transaction tax became fixed. We do not believe we can fill that legislative lacuna by judicial fiat. There is nothing to suggest that Section 247 (a) of the present Tax Code, which was inserted in 1985, was intended to be given retroactive application by the legislative authority. 16

(3) Whether Picop is Liablefor Documentary andScience Stamp Taxes.

As noted earlier, Picop issued sometime in 1977 long-term subordinated convertible debenture bonds with an aggregate face value of P100,000,000.00. Picop stated, and this was not disputed by the CIR, that the proceeds of the debenture bonds were in fact utilized to finance the BOI-registered operations of Picop. The CIR assessed documentary and science stamp taxes, amounting to P300,000.00, on the issuance of Picop's debenture bonds. It is claimed by Picop that its tax exemption — "exemption from all taxes under the National Internal Revenue Code, except income tax" on a declining basis over a certain period of time — includes exemption from the documentary and science stamp taxes imposed under the NIRC.

The CIR, upon the other hand, stresses that the tax exemption under the Investment Incentives Act may be granted or recognized only to the extent that the claimant Picop was engaged in registered operations, i.e., operations forming part of its integrated pulp and paper project. 17 The borrowing of funds from the public, in the submission of the CIR, was not an activity included in Picop's registered operations. The CTA adopted the view of the CIR and held that "the issuance of convertible debenture bonds [was] not synonymous [with] the manufactur[ing] operations of an integrated pulp and paper mill." 18

The Court of Appeals took a less rigid view of the ambit of the tax exemption granted to registered pioneer enterprises. Said the Court of Appeals:

. . . PICOP's explanation that the debenture bonds were issued to finance its registered operation is logical and is unrebutted. We are aware that tax exemptions must be applied strictly against the beneficiary in order to deter their abuse. It would indeed be altogether a different matter if there is a showing that the issuance of the debenture bonds had no bearing whatsoever on the registered operations PICOP and that they were issued in connection with a totally different business undertaking of PICOP other than its registered operation. There is, however, a dearth of evidence in this regard. It cannot be denied that PICOP needed funds for its operations. One of the means it used to raise said funds was to issue debenture bonds. Since the money raised thereby was to be used in its registered operation, PICOP should enjoy the incentives granted to it by R.A. 5186, one of which is the exemption from payment of all taxes under the National Internal Revenue Code, except income taxes, otherwise the purpose of the incentives would be defeated. Documentary and science stamp taxes on debenture bonds are certainly not income taxes. 19 (Emphasis supplied)

Tax exemptions are, to be sure, to be "strictly construed," that is, they are not to be extended beyond the ordinary and reasonable intendment of the language actually used by the legislative

authority in granting the exemption. The issuance of debenture bonds is certainly conceptually distinct from pulping and paper manufacturing operations. But no one contends that issuance of bonds was a principal or regular business activity of Picop; only banks or other financial institutions are in the regular business of raising money by issuing bonds or other instruments to the general public. We consider that the actual dedication of the proceeds of the bonds to the carrying out of Picop's registered operations constituted a sufficient nexus with such registered operations so as to exempt Picop from stamp taxes ordinarily imposed upon or in connection with issuance of such bonds. We agree, therefore, with the Court of Appeals on this matter that the CTA and the CIR had erred in rejecting Picop's claim for exemption from stamp taxes.

It remains only to note that after commencement of the present litigation before the CTA, the BIR took the position that the tax exemption granted by R.A. No. 5186, as amended, does include exemption from documentary stamp taxes on transactions entered into by BOI-registered enterprises. BIR Ruling No. 088, dated 28 April 1989, for instance, held that a registered preferred pioneer enterprise engaged in the manufacture of integrated circuits, magnetic heads, printed circuit boards, etc., is exempt from the payment of documentary stamp taxes. The Commissioner said:

You now request a ruling that as a preferred pioneer enterprise, you are exempt from the payment of Documentary Stamp Tax (DST).

In reply, please be informed that your request is hereby granted. Pursuant to Section 46 (a) of Presidential Decree No. 1789, pioneer enterprises registered with the BOI are exempt from all taxes under the National Internal Revenue Code, except from all taxes under the National Internal Revenue Code, except income tax, from the date the area of investment is included in the Investment Priorities Plan to the following extent:

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Accordingly, your company is exempt from the payment of documentary stamp tax to the extent of the percentage aforestated on transactions connected with the registered business activity. (BIR Ruling No. 111-81) However, if said transactions conducted by you require the execution of a taxable document with other parties, said parties who are not exempt shall be the one directly liable for the tax. (Sec. 173, Tax Code, as amended; BIR Ruling No. 236-87) In other words, said parties shall be liable to the same percentage corresponding to your tax exemption. (Emphasis supplied)

Similarly, in BIR Ruling No. 013, dated 6 February 1989, the Commissioner held that a registered pioneer enterprise producing polyester filament yarn was entitled to exemption "from the documentary stamp tax on [its] sale of real property in Makati up to December 31, 1989." It appears clear to the Court that the CIR, administratively at least, no longer insists on the position it originally took in the instant case before the CTA.

II

(1) Whether Picop is entitledto deduct against currentincome interest paymentson loans for the purchaseof machinery and equipment.

In 1969, 1972 and 1977, Picop obtained loans from foreign creditors in order to finance the purchase of machinery and equipment needed for its operations. In its 1977 Income Tax Return, Picop claimed interest payments made in 1977, amounting to P42,840,131.00, on these loans as a deduction from its 1977 gross income.

The CIR disallowed this deduction upon the ground that, because the loans had been incurred for the purchase of machinery and equipment, the interest payments on those loans should have been capitalized instead and claimed as a depreciation deduction taking into account the adjusted basis of the machinery and equipment (original acquisition cost plus interest charges) over the useful life of such assets.

Both the CTA and the Court of Appeals sustained the position of Picop and held that the interest deduction claimed by Picop was proper and allowable. In the instant Petition, the CIR insists on its original position.

We begin by noting that interest payments on loans incurred by a taxpayer (whether BOI-registered or not) are allowed by the NIRC as deductions against the taxpayer's gross income. Section 30 of the 1977 Tax Code provided as follows:

Sec. 30. Deduction from Gross Income. — The following may be deducted from gross income:

(a) Expenses:

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(b) Interest:

(1) In general. — The amount of interest paid within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income under this Title: . . . (Emphasis supplied)

Thus, the general rule is that interest expenses are deductible against gross income and this certainly includes interest paid under loans incurred in connection with the carrying on of the business of the taxpayer. 20 In the instant case, the CIR does not dispute that the interest payments were made by Picop on loansincurred in connection with the carrying on of the registered operations of Picop, i.e., the financing of the purchase of machinery and equipment actually used in the registered operations of Picop. Neither does the CIR deny that such interest payments were legally due and demandable under the terms of such loans, and in fact paid by Picop during the tax year 1977.

The CIR has been unable to point to any provision of the 1977 Tax Code or any other Statute that requires the disallowance of the interest payments made by Picop. The CIR invokes Section 79 of Revenue Regulations No. 2 as amended which reads as follows:

Sec. 79. Interest on Capital. — Interest calculated for cost-keeping or other purposes on account of capital or surplus invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable deduction from gross income. (Emphases supplied)

We read the above provision of Revenue Regulations No. 2 as referring to so called "theoretical interest," that is to say, interest "calculated" or computed (and not incurred or paid) for the purpose of determining the "opportunity cost" of investing funds in a given business. Such "theoretical" or imputed interest does notarise from a legally demandable interest-bearing obligation incurred by the taxpayer who however wishes to find out, e.g., whether he would have been better off by lending out his funds and earning interest rather than investing such funds in his business. One thing that Section 79 quoted above makes clear is that interest which does constitute a charge arising under an interest-bearing obligation is an allowable deduction from gross income.

It is claimed by the CIR that Section 79 of Revenue Regulations No. 2 was "patterned after" paragraph 1.266-1 (b), entitled "Taxes and Carrying Charges Chargeable to Capital Account and Treated as Capital Items" of the U.S. Income Tax Regulations, which paragraph reads as follows:

(B) Taxes and Carrying Charges. — The items thus chargeable to capital accounts are —

(11) In the case of real property, whether improved or unimproved and whether productive or nonproductive.

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds). 21

The truncated excerpt of the U.S. Income Tax Regulations quoted by the CIR needs to be related to the relevant provisions of the U.S. Internal Revenue Code, which provisions deal with the general topic of adjusted basis for determining allowable gain or loss on sales or exchanges of property and allowable depreciation and depletion of capital assets of the taxpayer:

Present Rule. The Internal Revenue Code, and the Regulations promulgated thereunder provide that "No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations, to treat such taxes orcharges as so chargeable."

At the same time, under the adjustment of basis provisions which have just been discussed, it is provided that adjustment shall be made for all "expenditures, receipts, losses, or other items" properly chargeable to a capital account, thus including taxes and carrying charges; however, an exception exists, in which event such adjustment to the capital account is not made, with respect to taxes and carrying charges which the taxpayer has not elected to capitalize but for which a deduction instead has been taken. 22 (Emphasis supplied)

The "carrying charges" which may be capitalized under the above quoted provisions of the U.S. Internal Revenue Code include, as the CIR has pointed out, interest on a loan "(but not theoretical interest of a taxpayer using his own funds)." What the CIR failed to point out is that such "carrying charges" may, at the election of the taxpayer, either be (a) capitalized in which case the cost basis of the capital assets, e.g., machinery and equipment, will be adjusted by adding the amount of such interest payments or alternatively, be (b) deducted from gross income of the taxpayer. Should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments. In other words, the taxpayer is not entitled to both the deduction from

gross income and the adjusted (increased) basis for determining gain or loss and the allowable depreciation charge. The U.S. Internal Revenue Code does not prohibit the deduction of interest on a loan obtained for purchasing machinery and equipment against gross income, unless the taxpayer has also or previously capitalized the same interest payments and thereby adjusted the cost basis of such assets.

We have already noted that our 1977 NIRC does not prohibit the deduction of interest on a loan incurred for acquiring machinery and equipment. Neither does our 1977 NIRC compel the capitalization of interest payments on such a loan. The 1977 Tax Code is simply silent on a taxpayer's right to elect one or the other tax treatment of such interest payments. Accordingly, the general rule that interest payments on a legally demandable loan are deductible from gross income must be applied.

The CIR argues finally that to allow Picop to deduct its interest payments against its gross income would be to encourage fraudulent claims to double deductions from gross income:

[t]o allow a deduction of incidental expense/cost incurred in the purchase of fixed asset in the year it was incurred would invite tax evasion through fraudulent application of double deductions from gross income. 23 (Emphases supplied)

The Court is not persuaded. So far as the records of the instant cases show, Picop has not claimed to be entitled to double deduction of its 1977 interest payments. The CIR has neither alleged nor proved that Picop had previously adjusted its cost basis for the machinery and equipment purchased with the loan proceeds by capitalizing the interest payments here involved. The Court will not assume that the CIR would be unable or unwilling to disallow "a double deduction" should Picop, having deducted its interest cost from its gross income, also attempt subsequently to adjust upward the cost basis of the machinery and equipment purchased and claim, e.g., increased deductions for depreciation.

We conclude that the CTA and the Court of Appeals did not err in allowing the deductions of Picop's 1977 interest payments on its loans for capital equipment against its gross income for 1977.

(2) Whether Picop is entitledto deduct against currentincome net operating lossesincurred by Rustan Pulpand Paper Mills, Inc.

On 18 January 1977, Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred, assigned and conveyed to Picop as the surviving corporation. The entire subscribed and outstanding capital stock of RPPM and RMC would be exchanged for 2,891,476 fully paid up Class "A" common stock of Picop (with a par value of P10.00) and 149,848 shares of preferred stock of Picop (with a par value of P10.00), to be issued by Picop, the result being that Picop would wholly own both RPPM and RMC while the stockholders of RPPM and RMC would join the ranks of Picop's shareholders. In addition, Picop paid off the obligations of RPPM to the Development Bank of the Philippines ("DBP") in the amount of P68,240,340.00, by issuing 6,824,034 shares of preferred stock (with a par value of P10.00) to the DBP. The merger agreement was approved in 1977 by the creditors and stockholders of Picop, RPPM and RMC and by the Securities and Exchange Commission. Thereupon, on 30 November 1977, apparently the effective date of merger, RPPM and RMC were dissolved. The Board of Investments approved the merger agreement on 12 January 1978.

It appears that RPPM and RMC were, like Picop, BOI-registered companies. Immediately before merger effective date, RPPM had over preceding years accumulated losses in the total amount of P81,159,904.00. In its 1977 Income Tax Return, Picop claimed P44,196,106.00 of RPPM's accumulated losses as a deduction against Picop's 1977 gross income. 24

Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding shares of RMC stock to San Miguel Corporation for the sum of P38,900,000.00, and reported a gain of P9,294,849.00 from this transaction. 25

In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186 which provides as follows:

Sec. 7. Incentives to Registered Enterprise. — A registered enterprise, to the extent engaged in a preferred area of investment, shall be granted the following incentive benefits:

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(c) Net Operating Loss Carry-over. — A net operating loss incurred in any of the first ten years of operations may be carried over as a deduction from taxable income for the six years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the six taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining five years. The net operating loss shall be computed in accordance with the provisions of the National Internal Revenue Code, any provision of this Act to the contrary notwithstanding, except that income not taxable either in whole or in part under this or other laws shall be included in gross income. (Emphasis supplied)

Picop had secured a letter-opinion from the BOI dated 21 February 1977 — that is, after the date of the agreement of merger but before the merger became effective — relating to the deductibility of the previous losses of RPPM under Section 7 (c) of R.A. No. 5186 as amended. The pertinent portions of this BOI opinion, signed by BOI Governor Cesar Lanuza, read as follows:

2) PICOP will not be allowed to carry over the losses of Rustan prior to the legal dissolution of the latter because at that time the two (2) companies still had separate legal personalities;

3) After BOI approval of the merger, PICOP can no longer apply for the registration of the registered capacity of Rustan because with the approved merger, such registered capacity of Rustan transferred to PICOP will have the same registration date as that of Rustan. In this case, the previous losses of Rustan may be carried over by PICOP, because with the merger, PICOP assumes all the rights and obligations of Rustan subject, however, to the period prescribed for carrying over of such losses. 26 (Emphasis supplied)

Curiously enough, Picop did not also seek a ruling on this matter, clearly a matter of tax law, from the Bureau of Internal Revenue. Picop chose to rely solely on the BOI letter-opinion.

The CIR disallowed all the deductions claimed on the basis of RPPM's losses, apparently on two (2) grounds. Firstly, the previous losses were incurred by "another taxpayer," RPPM, and not by Picop in connection with Picop's own registered operations. The CIR took the view that Picop, RPPM and RMC were merged into one (1) corporate personality only on 12 January 1978, upon approval of the merger agreement by the BOI. Thus, during the taxable year 1977, Picop on the one hand and RPPM and RMC on the other, still had their separate juridical personalities. Secondly, the CIR alleged that these losses had been incurred by RPPM "from the borrowing of funds" and not from carrying out of RPPM's registered operations. We focus on the first ground. 27

The CTA upheld the deduction claimed by Picop; its reasoning, however, is less than crystal clear, especially in respect of its view of what the U.S. tax law was on this matter. In any event, the CTA apparently fell back on the BOI opinion of 21 February 1977 referred to above. The CTA said:

Respondent further averred that the incentives granted under Section 7 of R.A. No. 5186 shall be available only to the extent in which they are engaged in registered operations, citing Section 1 of Rule IX of the Basic Rules and Regulations to Implement the Intent and Provisions of the Investment Incentives Act, R.A. No. 5186.

We disagree with respondent. The purpose of the merger was to rationalize the container board industry and not to take advantage of the net losses incurred by RPPMI prior to the stock swap. Thus, when stock of a corporation is purchased in order to take advantage of the corporation's net operating loss incurred in years prior to the purchase, the corporation thereafter entering into a trade or business different from that in which it was previously engaged, the net operating loss carry-over may be entirely lost. [IRC (1954), Sec. 382(a), Vol. 5, Mertens, Law of Federal Income Taxation, Chap. 29.11a, p. 103]. 28 Furthermore, once the BOI approved the merger agreement, the registered capacity of Rustan shall be transferred to PICOP, and the previous losses of Rustan may be carried over by PICOP by operation of law. [BOI ruling dated February 21, 1977 (Exh. J-1)] It is clear therefrom, that the deduction availed of under Section 7(c) of R.A. No. 5186 was only proper." (pp. 38-43,Rollo of SP No. 20070) 29 (Emphasis supplied)

In respect of the above underscored portion of the CTA decision, we must note that the CTA in fact overlooked the statement made by petitioner's counsel before the CTA that:

Among the attractions of the merger to Picop was the accumulated net operating loss carry-over of RMC that it might possibly use to relieve it (Picop) from its income taxes, under Section 7 (c) of R.A.5186. Said section provides:

xxx xxx xxx

With this benefit in mind, Picop addressed three (3) questions to the BOI in a letter dated November 25, 1976. The BOI replied on February 21, 1977 directly answering the three (3) queries. 30 (Emphasis supplied)

The size of RPPM's accumulated losses as of the date of the merger — more than P81,000,000.00 — must have constituted a powerful attraction indeed for Picop.

The Court of Appeals followed the result reached by the CTA. The Court of Appeals, much like the CTA, concluded that since RPPM was dissolved on 30 November 1977, its accumulated losses were appropriately carried over by Picop in the latter's 1977 Income Tax Return "because by that time RPPMI and Picop were no longer separate and different taxpayers." 31

After prolonged consideration and analysis of this matter, the Court is unable to agree with the CTA and Court of Appeals on the deductibility of RPPM's accumulated losses against Picop's 1977 gross income.

It is important to note at the outset that in our jurisdiction, the ordinary rule — that is, the rule applicable in respect of corporations not registered with the BOI as a preferred pioneer enterprise — is that net operating losses cannot be carried over. Under our Tax Code, both in 1977 and at present, losses may be deducted from gross income only if such losses were actually sustained in the same year that they are deducted or charged off. Section 30 of the 1977 Tax Code provides:

Sec. 30. Deductions from Gross Income. — In computing net income, there shall be allowed as deduction —

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(d) Losses:

(1) By Individuals. — In the case of an individual, losses actually sustained during the taxable yearand not compensated for by an insurance or otherwise —

(A) If incurred in trade or business;

xxx xxx xxx

(2) By Corporations. — In a case of a corporation, all losses actually sustained and charged off within the taxable year and not compensated for by insurance or otherwise.

(3) By Non-resident Aliens or Foreign Corporations. — In the case of a non-resident alien individual or a foreign corporation, the losses deductible are those actually sustained during the year incurred in business or trade conducted within the Philippines, . . . 32 (Emphasis supplied)

Section 76 of the Philippine Income Tax Regulations (Revenue Regulation No. 2, as amended) is even more explicit and detailed:

Sec. 76. When charges are deductible. — Each year's return, so far as practicable, both as to gross income and deductions therefrom should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges,he can not deduct them from the income of the next or any succeeding year. . . .

xxx xxx xxx

. . . . If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year including such amount of loss in the deduction from gross income and may in

proper cases file a claim for refund of the excess paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained. (Emphases supplied)

It is thus clear that under our law, and outside the special realm of BOI-registered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary, losses must be deducted against current income in the taxable year when such losses were incurred. Moreover, such losses may be charged offonly against income earned in the same taxable year when the losses were incurred.

Thus it is that R.A. No. 5186 introduced the carry-over of net operating losses as a very special incentive to be granted only to registered pioneer enterprises and only with respect to their registered operations. The statutory purpose here may be seen to be the encouragement of the establishment and continued operation of pioneer industries by allowing the registered enterprise to accumulate its operating losses which may be expected during the early years of the enterprise and to permit the enterprise to offset such losses against income earned by it in later years after successful establishment and regular operations. To promote its economic development goals, the Republic foregoes or defers taxing the income of the pioneer enterprise until after that enterprise has recovered or offset its earlier losses. We consider that the statutory purpose can be served only if the accumulated operating losses are carried over and charged off against income subsequently earned and accumulated by the same enterprise engaged in the same registered operations.

In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. RPPM far from benefiting from the tax incentive granted by the BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the much larger group of Picop's stockholders. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM. Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same registered operations which earlier had sustained losses. We consider and so hold that there is nothing in Section 7 (c) of R.A. No. 5186 which either requires or permits such a result. Indeed, that result makes non-sense of the legislative purpose which may be seen clearly to be projected by Section 7 (c), R.A. No. 5186.

The CTA and the Court of Appeals allowed the offsetting of RPPM's accumulated operating losses against Picop's 1977 gross income, basically because towards the end of the taxable year 1977, upon the arrival of the effective date of merger, only one (1) corporation, Picop, remained. The losses suffered by RPPM's registered operations and the gross income generated by Picop's own registered operations now came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not believe that that single purely technical factor is enough to authorize and justify the deduction claimed by Picop. Picop's claim for deduction is not only bereft of statutory basis; it does violence to the legislative intent which animates the tax incentive granted by Section 7 (c) of R.A. No. 5186. In granting the extraordinary privilege and incentive of a net operating loss carry-over to BOI-registered pioneer enterprises, the legislature could not have intended to require the Republic to forego tax revenues in order to benefit

a corporation which had run no risks and suffered no losses, but had merely purchased another's losses.

Both the CTA and the Court of Appeals appeared much impressed not only with corporate technicalities but also with the U.S. tax law on this matter. It should suffice, however, simply to note that in U.S. tax law, the availability to companies generally of operating loss carry-overs and of operating loss carry-backs is expressly provided and regulated in great detail by statute. 33 In our jurisdiction, save for Section 7 (c) of R.A. No. 5186, no statute recognizes or permits loss carry-overs and loss carry-backs. Indeed, as already noted, our tax law expressly rejects the very notion of loss carry-overs and carry-backs.

We conclude that the deduction claimed by Picop in the amount of P44,196,106.00 in its 1977 Income Tax Return must be disallowed.

(3) Whether Picop is entitledto deduct against currentincome certain claimedfinancial guarantee expenses.

In its Income Tax Return for 1977, Picop also claimed a deduction in the amount of P1,237,421.00 as financial guarantee expenses.

This deduction is said to relate to chattel and real estate mortgages required from Picop by the Philippine National Bank ("PNB") and DBP as guarantors of loans incurred by Picop from foreign creditors. According to Picop, the claimed deduction represents registration fees and other expenses incidental to registration of mortgages in favor of DBP and PNB.

In support of this claimed deduction, Picop allegedly showed its own vouchers to BIR Examiners to prove disbursements to the Register of Deeds of Tandag, Surigao del Sur, of particular amounts. In the proceedings before the CTA, however, Picop did not submit in evidence such vouchers and instead presented one of its employees to testify that the amount claimed had been disbursed for the registration of chattel and real estate mortgages.

The CIR disallowed this claimed deduction upon the ground of insufficiency of evidence. This disallowance was sustained by the CTA and the Court of Appeals. The CTA said:

No records are available to support the abovementioned expenses. The vouchers merely showed that the amounts were paid to the Register of Deeds and simply cash account. Without the supporting papers such as the invoices or official receipts of the Register of Deeds, these vouchers standing alone cannot prove that the payments made were for the accrued expenses in question.The best evidence of payment is the official receipts issued by the Register of Deeds. The testimony of petitioner's witness that the official receipts and cash vouchers were shown to the Bureau of Internal Revenue will not suffice if no records could be presented in court for proper marking and identification. 34 Emphasis supplied)

The Court of Appeals added:

The mere testimony of a witness for PICOP and the cash vouchers do not suffice to establish its claim that registration fees were paid to the Register of Deeds for the registration of real estate and chattel mortgages in favor of Development Bank of the Philippines and the Philippine National Bank as guarantors of PICOP's loans. The

witness could very well have been merely repeating what he was instructed to say regardless of the truth, while the cash vouchers, which we do not find on file, are not said to provide the necessary details regarding the nature and purpose of the expenses reflected therein. PICOP should have presented, through the guarantors, its owner's copy of the registered titles with the lien inscribed thereon as well as an official receipt from the Register of Deeds evidencing payment of the registration fee. 35 (Emphasis supplied)

We must support the CTA and the Court of Appeals in their foregoing rulings. A taxpayer has the burden of proving entitlement to a claimed deduction. 36 In the instant case, even Picop's own vouchers were not submitted in evidence and the BIR Examiners denied that such vouchers and other documents had been exhibited to them. Moreover, cash vouchers can only confirm the fact of disbursement but not necessarily the purpose thereof. 37 The best evidence that Picop should have presented to support its claimed deduction were the invoices and official receipts issued by the Register of Deeds. Picop not only failed to present such documents; it also failed to explain the loss thereof, assuming they had existed before. 38 Under the best evidence rule, 39 therefore, the testimony of Picop's employee was inadmissible and was in any case entitled to very little, if any, credence.

We consider that entitlement to Picop's claimed deduction of P1,237,421.00 was not adequately shown and that such deduction must be disallowed.

III

(1) Whether Picop had understatedits sales and overstated itscost of sales for 1977.

In its assessment for deficiency income tax for 1977, the CIR claimed that Picop had understated its sales by P2,391,644.00 and, upon the other hand, overstated its cost of sales by P604,018.00. Thereupon, the CIR added back both sums to Picop's net income figure per its own return.

The 1977 Income Tax Return of Picop set forth the following figures:

Sales (per Picop's Income Tax Return):

Paper P 537,656,719.00

Timber P 263,158,132.00

———————

Total Sales P 800,814,851.00

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

Upon the other hand, Picop's Books of Accounts reflected higher sales figures:

Sales (per Picop's Books of Accounts):

Paper P 537,656,719.00

Timber P 265,549,776.00

———————

Total Sales P 803,206,495.00

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

The above figures thus show a discrepancy between the sales figures reflected in Picop's Books of Accounts and the sales figures reported in its 1977 Income Tax Return, amounting to: P2,391,644.00.

The CIR also contended that Picop's cost of sales set out in its 1977 Income Tax Return, when compared with the cost figures in its Books of Accounts, was overstated:

Cost of Sales(per Income Tax Return) P607,246,084.00Cost of Sales(per Books of Accounts) P606,642,066.00

———————

Discrepancy P 604,018.00============

Picop did not deny the existence of the above noted discrepancies. In the proceedings before the CTA, Picop presented one of its officials to explain the foregoing discrepancies. That explanation is perhaps best presented in Picop's own words as set forth in its Memorandum before this Court:

. . . that the adjustment discussed in the testimony of the witness, represent the best and most objective method of determining in pesos the amount of the correct and actual export sales during the year. It was this correct and actual export sales and costs of sales that were reflected in the income tax return and in the audited financial statements. These corrections did not result in realization of income and should not give rise to any deficiency tax.

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What are the facts of this case on this matter? Why were adjustments necessary at the year-end?

Because of PICOP's procedure of recording its export sales (reckoned in U.S. dollars) on the basis of a fixed rate, day to day and month to month, regardless of the actual exchange rate and without waiting when the actual proceeds are received. In other words, PICOP recorded its export sales at a pre-determined fixed exchange rate. That pre-determined rate was decided upon at the beginning of the year and continued to be used throughout the year.

At the end of the year, the external auditors made an examination. In that examination, the auditors determined with accuracy the actual dollar proceeds of the export sales received. What exchange rate was used by the auditors to convert these

actual dollar proceeds into Philippine pesos? They used the average of the differences between (a) the recorded fixed exchange rate and (b) the exchange rate at the time the proceeds were actually received. It was this rate at time of receipt of the proceeds that determined the amount of pesos credited by the Central Bank (through the agent banks) in favor of PICOP. These accumulated differences were averaged by the external auditors and this was what was used at the year-end for income tax and other government-report purposes. (T.s.n., Oct. 17/85, pp. 20-25) 40

The above explanation, unfortunately, at least to the mind of the Court, raises more questions than it resolves. Firstly, the explanation assumes that all of Picop's sales were export sales for which U.S. dollars (or other foreign exchange) were received. It also assumes that the expenses summed up as "cost of sales" were all dollar expenses and that no peso expenses had been incurred. Picop's explanation further assumes that a substantial part of Picop's dollar proceeds for its export sales were not actually surrendered to the domestic banking system and seasonably converted into pesos; had all such dollar proceeds been converted into pesos, then the peso figures could have been simply added up to reflect the actual peso value of Picop's export sales. Picop offered no evidence in respect of these assumptions, no explanation why and how a "pre-determined fixed exchange rate" was chosen at the beginning of the year and maintained throughout. Perhaps more importantly, Picop was unable to explain why its Books of Accounts did not pick up the same adjustments that Picop's External Auditors were alleged to have made for purposes of Picop's Income Tax Return. Picop attempted to explain away the failure of its Books of Accounts to reflect the same adjustments (no correcting entries, apparently) simply by quoting a passage from a case where this Court refused to ascribe much probative value to the Books of Accounts of a corporate taxpayer in a tax case. 41 What appears to have eluded Picop, however, is that its Books of Accounts, which are kept by its own employees and are prepared under its control and supervision, reflect what may be deemed to be admissions against interest in the instant case. For Picop's Books of Accounts precisely show higher sales figures andlower cost of sales figures than Picop's Income Tax Return.

It is insisted by Picop that its Auditors' adjustments simply present the "best and most objective" method of reflecting in pesos the "correct and ACTUAL export sales" 42 and that the adjustments or "corrections" "did not result in realization of [additional] income and should not give rise to any deficiency tax." The correctness of this contention is not self-evident. So far as the record of this case shows, Picop did not submit in evidence the aggregate amount of its U.S. dollar proceeds of its export sales; neither did it show the Philippine pesos it had actually received or been credited for such U.S. dollar proceeds. It is clear to this Court that the testimonial evidence submitted by Picop fell far short of demonstrating the correctness of its explanation.

Upon the other hand, the CIR has made out at least a prima facie case that Picop had understated its sales and overstated its cost of sales as set out in its Income Tax Return. For the CIR has a right to assume that Picop's Books of Accounts speak the truth in this case since, as already noted, they embody what must appear to be admissions against Picop's own interest.

Accordingly, we must affirm the findings of the Court of Appeals and the CTA.

(2) Whether Picop is liable forthe corporate developmenttax of five percent (5%)of its income for 1977.

The five percent (5%) corporate development tax is an additional corporate income tax imposed in Section 24 (e) of the 1977 Tax Code which reads in relevant part as follows:

(e) Corporate development tax. — In addition to the tax imposed in subsection (a) of this section, an additional tax in an amount equivalent to 5 per cent of the same taxable net income shall be paid by a domestic or a resident foreign corporation; Provided, That this additional tax shall be imposed only if the net income exceeds 10 per cent of the net worth, in case of a domestic corporation, or net assets in the Philippines in case of a resident foreign corporation: . . . .

The additional corporate income tax imposed in this subsection shall be collected and paid at the same time and in the same manner as the tax imposed in subsection (a) of this section.

Since this five percent (5%) corporate development tax is an income tax, Picop is not exempted from it under the provisions of Section 8 (a) of R.A. No. 5186.

For purposes of determining whether the net income of a corporation exceeds ten percent (10%) of its net worth, the term "net worth" means the stockholders' equity represented by the excess of the total assets over liabilities as reflected in the corporation's balance sheet provided such balance sheet has been prepared in accordance with generally accepted accounting principles employed in keeping the books of the corporation. 43

The adjusted net income of Picop for 1977, as will be seen below, is P48,687,355.00. Its net worth figure or total stockholders' equity as reflected in its Audited Financial Statements for 1977 is P464,749,528.00. Since its adjusted net income for 1977 thus exceeded ten percent (10%) of its net worth, Picop must be held liable for the five percent (5%) corporate development tax in the amount of P2,434,367.75.

Recapitulating, we hold:

(1) Picop is liable for the thirty-five percent (35%) transaction tax in the amount of P3,578,543.51.

(2) Picop is not liable for interest and surcharge on unpaid transaction tax.

(3) Picop is exempt from payment of documentary and science stamp taxes in the amount of P300,000.00 and the compromise penalty of P300.00.

(4) Picop is entitled to its claimed deduction of P42,840,131.00 for interest payments on loans for, among other things, the purchase of machinery and equipment.

(5) Picop's claimed deduction in the amount of P44,196,106.00 for the operating losses previously incurred by RPPM, is disallowed for lack of merit.

(6) Picop's claimed deduction for certain financial guarantee expenses in the amount P1,237,421.00 is disallowed for failure adequately to prove such expenses.

(7) Picop has understated its sales by P2,391,644.00 and overstated its cost of sales by P604,018.00, for 1977.

(8) Picop is liable for the corporate development tax of five percent (5%) of its adjusted net income for 1977 in the amount of P2,434,367.75.

Considering conclusions nos. 4, 5, 6, 7 and 8, the Court is compelled to hold Picop liable for deficiency income tax for the year 1977 computed as follows:

Deficiency Income Tax

Net Income Per Return P 258,166.00

Add:

Unallowable Deductions

(1) Deduction of netoperating lossesincurred by RPPM P 44,196,106.00

(2) Unexplained financialguarantee expenses P 1,237,421.00

(3) Understatement ofSales P 2,391,644.00

(4) Overstatement ofCost of Sales P 604,018.00

——————

Total P 48,429,189.00

——————

Net Income as Adjusted P 48,687,355.00

===========

Income Tax Due Thereon 44 P 17,030,574.00

Less:

Tax Already Assessed perReturn 80,358.00

——————

Deficiency Income Tax P 16,560,216.00

Add:

Five percent (5%) CorporateDevelopment Tax P 2,434,367.00

Total Deficiency Income Tax P 18,994,583.00

===========

Add:

Five percent (5%) surcharge 45 P 949,729.15

——————

Total Deficiency Income Tax

with surcharge P 19,944,312.15

Add:

Fourteen percent (14%)

interest from 15 April

1978 to 14 April 1981 46 P 8,376,610.80

Fourteen percent (14%)

interest from 21 April

1983 to 20 April 1986 47 P 11,894,787.00

——————

Total Deficiency Income Tax

Due and Payable P 40,215,709.00

===========

WHEREFORE, for all the foregoing, the Decision of the Court of Appeals is hereby MODIFIED and Picop is hereby ORDERED to pay the CIR the aggregate amount of P43,794,252.51 itemized as follows:

(1) Thirty-five percent (35%)

transaction tax P 3,578,543.51

(2) Total Deficiency Income

Tax Due 40,215,709.00

———————

Aggregate Amount Due and Payable P 43,794,252.51

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

No pronouncement as to costs.

SO ORDERED.

Narvasa, C.J., Regalado, Davide, Jr., Romero, Bellosillo, Melo, Puno, Kapunan, Mendoza, Francisco, Hermosisima, Jr. and Panganiban, JJ., concur.

EN BANC

G.R. No. L-13325             April 20, 1961

SANTIAGO GANCAYCO, petitioner, vs.THE COLLECTOR OF INTERNAL REVENUE, respondent.

Benjamin J. Molina for petitioner.Office of the Solicitor General and Special Attorney Antonio A. Garces for respondent.

CONCEPCION, J.:

Petitioner Santiago Gancayco seeks the review of a decision of the Court of Tax Appeals, requiring him to pay P16,860.31, plus surcharge and interest, by way of deficiency income tax for the year 1949.

On May 10, 1950, Gancayco filed his income tax return for the year 1949. Two (2) days later, respondent Collector of Internal Revenue issued the corresponding notice advising him that his income tax liability for that year amounted P9,793.62, which he paid on May 15, 1950. A year later, on May 14, 1951, respondent wrote the communication Exhibit C, notifying Gancayco, inter alia, that, upon investigation, there was still due from him, a efficiency income tax for the year 1949, the sum of P29,554.05. Gancayco sought a reconsideration, which was part granted by respondent, who in a letter dated April 8, 1953 (Exhibit D), informed petitioner that his income tax defendant efficiency for 1949 amounted to P16,860.31. Gancayco urged another reconsideration (Exhibit O), but no action taken on this request, although he had sent several communications calling respondent's attention thereto.

On April 15, 1956, respondent issued a warrant of distraint and levy against the properties of Gancayco for the satisfaction of his deficiency income tax liability, and accordingly, the municipal treasurer of Catanauan, Quezon issued on May 29, 1956, a notice of sale of said property at public auction on June 19, 1956. Upon petition of Gancayco filed on June 16, 1956, the Court of Tax Appeal issued a resolution ordering the cancellation of the sale and directing that the same be readvertised at a future date, in accordance with the procedure established by the National Internal Revenue Code. Subsequently, or on June 22, 1956, Gancayco filed an amended petition praying that said Court:

(a) Issue a writ of preliminary injunction, enjoining the respondents from enforcing the collection of the alleged tax liability due from the petitioner through summary proceeding pending determination of the present case;

(b) After a review of the present case adjudge that the right of the government to enforce collection of any liability due on this account had already prescribed;

(c) That even assuming that prescription had not set in the objections of petitioner to the disallowance of the entertainment, representation and farming expenses be allowed;

x x x           x x x           x x x

In his answer respondent admitted some allegations the amended petition, denied other allegations thereof an set up some special defenses. Thereafter Gancayco received from the municipal treasurer of Catanauan, Quezon, another notice of auction sale of his properties, to take place on August 29, 1956. On motion of Gancayco, the Court of Tax Appeals, by resolution dated August 27, 1956, "cancelled" the aforementioned sale and enjoined respondent and the municipal treasurer of Catanauan, Quezon, from proceeding with the same. After appropriate proceedings, the Court of Tax Appeals rendered, on November 14, 1957, the decision adverted to above.

Gancayco maintains that the right to collect the deficiency income tax in question is barred by the statute of limitations. In this connection, it should be noted, however, that there are two (2) civil remedies for the collection of internal revenue taxes, namely: (a) by distraint of personal property and levy upon real property; and (b) by "judicial action" (Commonwealth Act 456, section 316). The first may not be availed of except within three (3) years after the "return is due or has been made ..." (Tax Code, section 51 [d] ). After the expiration of said Period, income taxes may not be legally and validly collected by distraint and/or levy (Collector of Internal Revenue v. Avelino, L-9202, November 19, 1956; Collector of Internal Revenue v. Reyes, L-8685, January 31, 1957; Collector of Internal Revenue v. Zulueta, L-8840, February 8, 1957; Sambrano v. Court of Tax Appeals, L-8652, March 30, 1957). Gancayco's income tax return for 1949 was filed on May 10, 1950; so that the warrant of distraint and levy issued on May 15, 1956, long after the expiration of said three-year period, was illegal and void, and so was the attempt to sell his properties in pursuance of said warrant.

The "judicial action" mentioned in the Tax Code may be resorted to within five (5) years from the date the return has been filed, if there has been no assessment, or within five (5) years from the date of the assessment made within the statutory period, or within the period agreed upon, in writing, by the Collector of Internal Revenue and the taxpayer. before the expiration of said five-year period, or within such extension of said stipulated period as may have been agreed upon, in writing, made before the expiration of the period previously situated, except that in the case of a false or fraudulent return with intent to evade tax or of a failure to file a return, the judicial action may be begun at any time within ten (10) years after the discovery of the falsity, fraud or omission (Sections 331 and 332 of the Tax Code). In the case at bar, respondent made three (3) assessments: (a) the original assessment of P9,793.62, made on May 12, 1950; (b) the first deficiency income tax assessment of May 14, 1951, for P29,554.05; and (c) the amended deficiency income tax assessment of April 8, 1953, for P16,860.31.

Gancayco argues that the five-year period for the judicial action should be counted from May 12, 1950, the date of the original assessment, because the income tax for 1949, he says, could have been collected from him since then. Said assessment was, however, not for the deficiency income tax involved in this proceedings, but for P9,793.62, which he paid forthwith. Hence, there never had been any cause for a judicial action against him, and, per force, no statute of limitations to speak of, in connection with said sum of P9,793.62.

Neither could said statute have begun to run from May 14, 1951, the date of the first deficiency income tax assessment or P29,554.05, because the same was, upon Gancayco's request, reconsidered or modified by the assessment made on April 8, 1953, for P16,860.31. Indeed, this last

assessment is what Gancayco contested in the amended petition filed by him with the Court of Tax Appeals. The amount involved in such assessment which Gancayco refused to pay and respondent tried to collect by warrant of distraint and/or levy, is the one in issue between the parties. Hence, the five-year period aforementioned should be counted from April 8, 1953, so that the statute of limitations does not bar the present proceedings, instituted on April 12, 1956, if the same is a judicial action, as contemplated in section 316 of the Tax Code, which petitioner denies, upon the ground that

a. "The Court of Tax Appeals does not have original jurisdiction to entertain an action for the collection of the tax due;

b. "The proper party to commence the judicial action to collect the tax due is the government, and

c. "The remedies provided by law for the collection of the tax are exclusive."

Said Section 316 provides:

The civil remedies for the collection of internal revenue taxes, fees, or charges, and any increment thereto resulting from delinquency shall be (a) by distraint of goods, chattels, or effects, and other personal property of whatever character, including stocks and other securities, debts, credits, bank accounts, and interest in and rights to personal property, and by levy upon real property; and (b) by judicial action. Either of these remedies or both simultaneously may be pursued in the discretion of the authorities charged with the collection of such taxes.

No exemption shall be allowed against the internal revenue taxes in any case.

Petitioner contends that the judicial action referred to in this provision is commenced by filing, with a court of first instance, of a complaint for the collection of taxes. This was true at the time of the approval of Commonwealth Act No. 456, on June 15, 1939. However, Republic Act No. 1125 has vested the Court of Tax Appeals, not only with exclusive appellate jurisdiction to review decisions of the Collector (now Commissioner) of Internal Revenue in cases involving disputed assessments, like the one at bar, but, also, with authority to decide "all cases involving disputed assessments of Internal Revenue taxes or customs duties pending determination before the court of first instance" at the time of the approval of said Act, on June 16, 1954 (Section 22, Republic Act No. 1125). Moreover, this jurisdiction to decide all cases involving disputed assessments of internal revenue taxes and customs duties necessarily implies the power to authorize and sanction the collection of the taxes and duties involved in such assessments as may be upheld by the Court of Tax Appeals. At any rate, the same now has the authority formerly vested in courts of first instance to hear and decide cases involving disputed assessments of internal revenue taxes and customs duties. Inasmuch as those cases filed with courts of first instance constituted judicial actions, such is, likewise, the nature of the proceedings before the Court of Tax Appeals, insofar as sections 316 and 332 of the Tax Code are concerned.

The question whether the sum of P16,860.31 is due from Gancayco as deficiency income tax for 1949 hinges on the validity of his claim for deduction of two (2) items, namely: (a) for farming expenses, P27,459.00; and (b) for representation expenses, P8,933.45.

Section 30 of the Tax Code partly reads:

(a) Expenses:

(1) In General — All the ordinary and necessary expenses paid or incurred during the taxable year incarrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses while away from home in the pursuit of a trade or business; and rentals or other payments required to be made as a condition to the continued use or possession, for the purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. (Emphasis supplied.)

Referring to the item of P27,459, for farming expenses allegedly incurred by Gancayco, the decision appealed from has the following to say:

No evidence has been presented as to the nature of the said "farming expenses" other than the bare statement of petitioner that they were spent for the "development and cultivation of (his) property". No specification has been made as to the actual amount spent for purchase of tools, equipment or materials, or the amount spent for improvement. Respondent claims that the entire amount was spent exclusively forclearing and developing the farm which were necessary to place it in a productive state. It is not, therefore, an ordinary expense but a capitol expenditure. Accordingly, it is not deductible but it may be amortized, in accordance with section 75 of Revenue Regulations No. 2, cited above. See also, section 31 of the Revenue Code which provides that in computing net income, no deduction shall in any case be allowed in respect of any amount paid out for new buildings or for permanent improvements, or betterments made toincrease the value of any property or estate. (Emphasis supplied.)

We concur in this view, which is a necessary consequence of section 31 of the Tax Code, pursuant to which:

(a) General Rule — In computing net income no deduction shall in any case be allowed in respect of —

(1) Personal, living, or family expenses;

(2) Any amount paid out for new buildings or for permanent improvements, or betterments made toincrease the value of any property or estate;

(3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made; or

(4) Premiums paid on any life insurance policy covering the life of any officer or employee, or any person financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy. (Emphasis supplied.)

Said view is, likewise, in accord with the consensus of the authorities on the subject.

Expenses incident to the acquisition of property follow the same rule as applied to payments made as direct consideration for the property. For example, commission paid in acquiring property are considered as representing part of the cost of the property acquired. The same treatment is to be accorded to amounts expended for maps, abstracts, legal opinions on

titles, recording fees and surveys. Other non-deductible expenses include amounts paid in connection with geological explorations, development and subdividing of real estate; clearing and grading; restoration of soil, drilling wells, architects's fees and similar types of expenditures. (4 Merten's Law of Federal Income Taxation, Sec. 25.20, pp. 348-349; see also sec. 75 of the income Regulation of the B.I.R.; Emphasis supplied.)

The cost of farm machinery, equipment and farm building represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may be regarded as investments of capital. (Merten's Law of Federal Income Taxation, supra, sec. 25.108, p. 525.)

Expenses for clearing off and grading lots acquired is a capital expenditure, representing part of the cost of the land and was not deductible as an expense. (Liberty Banking Co. v. Heiner 37 F [2d] 703 [8AFTR 100111] [CCA 3rd]; The B.L. Marble Chair Company v. U.S., 15 AFTR 746).

An item of expenditure, in order to be deductible under this section of the statute providing for the deduction of ordinary and necessary business expenses, must fall squarely within the language of the statutory provision. This section is intended primarily, although not always necessarily, to cover expenditures of a recurring nature where the benefit derived from the payment is realized and exhausted within the taxable year. Accordingly, if the result of the expenditure is the acquisition of an asset which has an economically useful life beyond the taxable year, no deduction of such payment may be obtained under the provisions of the statute. In such cases, to the extent that a deduction is allowable, it must be obtained under the provisions of the statute which permit deductions for amortization, depreciation, depletion or loss. (W.B. Harbeson Co. 24 BTA, 542; Clark Thread Co., 28 BTA 1128 aff'd 100 F [2d] 257 [CCA 3rd, 1938]; 4 Merten's Law of Federal Income Taxation, Sec. 25.17, pp. 337-338.)

Gancayco's claim for representation expenses aggregated P31,753.97, of which P22,820.52 was allowed, and P8,933.45 disallowed. Such disallowance is justified by the record, for, apart from the absence of receipts, invoices or vouchers of the expenditures in question, petitioner could not specify the items constituting the same, or when or on whom or on what they were incurred. The case of Cohan v. Commissioner, 39 F (2d) 540, cited by petitioner is not in point, because in that case there was evidence on the amounts spent and the persons entertained and the necessity of entertaining them, although there were no receipts an vouchers of the expenditures involved therein. Such is not the case of petitioner herein.

Being in accordance with the facts and law, the decision of the Court of Tax Appeals is hereby affirmed therefore, with costs against petitioner Santiago Cancayco. It is so ordered.

Padilla, Bautista Angelo, Labrador, Reyes, J.B.L., Barrera and Dizon, JJ., concur.