income tax cases

8/8/2019 Income Tax Cases

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G.R. No. L-14532 May 26, 1965

JOSE LEON GONZALES, petitioner-appellant,-versus-

THE HON. COURT OF TAX APPEALS and THE COLLECTOR OF INTERNAL REVENUE, respondents-appellees.

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

G.R. No. L-14533 May 26, 1965

JUANA G. GONZALES and FORTUNATO DE LEON, petitioners-appellants,-versus-

THE HON. COURT OF TAX APPEALS and THE COLLECTOR OF INTERAL REVENUE, respondents-appellees.

Statement. This is an appeal from the decision of the Court of Tax Appeals denying the refund of income taxes

imposed on, and paid by, Jose Leon Gonzales and Juana F. Gonzales.

The Facts. Jose Leon Gonzales and Juana F. Gonzales are brother and sister [the latter being married to Atty.Fortunato de Leon 1]. Both petitioners are co-heirs and co-owners, (one-sixth each) of a tract of land of 871, [982.]

square meters which they, along with four other co-heirs, inherited from their mother.

This realty, located at Caloocan, Rizal, was the object of expropriation proceedings, which this Court finallydecided in May 1954, in G.R. No.L-4918. Therein, we fixed the just compensation for the property at P1.50 persquare meter. We also ordered the payment of interest at the legal rate of 6% from January 25, 1947 (when theGovernment took possession of the property) to the date of payment, which payment was actually made onOctober 31, 1954. Excluded from the payment of interest was the sum of P28,850.00, the amount deposited by the

Government upon taking possession of the estate.

The total compensation paid the six heirs for the expropriated property amounted to P1,307,973.00. Subtractingtherefrom the amount of P28,850.00 just mentioned, there remained a difference of P1,279,123.00, the interest onwhich, at the legal rate of 6% per annum, totalled P535,587.70. Divided among the six heirs, this total gave ashare of P89,305.61 as interest to each of them.

Upon the amounts received from the Government, Jose Leon Gonzales and Juana F. Gonzales, were eachascertained to have made a capital gain of P213,328.82 [P1,279,973.00 2 divided by 6 heirs], and each of them tohave received the amount of P89,309.61 as share in the interests of P535,857.70 (this, sum is divided by 6). Atentative return for 1954 was thus prepared and filed for each of the two petitioners describing the amounts ofP213,328.82 as capital gain, and in addition, the amount of P89,309.61 as ordinary income. On the basis of such

income, each of the petitioners was assessed P86,166.00.

The Government paid to petitioners the proceeds of the expropriation award and interest through the People'sHomesite and Housing Corporation sometime in October 1954 the last check having been delivered on November4, 1954. However, the sum of P532,234.70 was retained by the Housing Corporation; and on November 18, 1954,at the request of respondent Collector, it turned over to the Bureau of Internal Revenue the amount ofP516,007.00 representing income taxes reportedly due and owing from the six co-heirs of the estate. Therefore,petitioners Jose Leon Gonzales and his sister Juana F. Gonzales were each credited the amount of P86,166.00 as

payment of their income tax. (Official Receipts Nos. 520491 and 520496 dated November 19, 1954)

On February 29, 1956, petitioner Juana F. Gonzales wrote the respondent Collector a letter, seeking the refund of

P24,426.00 allegedly representing excess payment of income taxes for 1954. The letter pertinently stated:

We respectively contend that the assessment was erroneous in that the amount of P89,309.61 representinginterest, was considered as ordinary income and not merely capital gain. If the interest was computed ascapital gain, there shall be due and owing from your office the amount of P24,426.00 assuming for

argument's sake that your assessment was correct. (Exhs. H & 2, also par. 22, "Stifacts")

On November 5, 1956, petitioner Jose Leon Gonzales also wrote a letter to said respondent requesting refund of asimilar amount of P24,426.00 for the same reasons as his co-petitioner. No action appears to have been taken onthis refund claim.


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On November 12, 1956, respondent Collector denied the request of Juana F. Gonzales for refund of P24,426.00.

The Suits. So on November 15, 1956, Jose Leon Gonzales and Juana F. Gonzales submitted to the Court ofTax Appeals a joint petition seeking a refund, this time of the amount of P86,166.00 for each of the two petitioners; but the next day, both petitioners amended their petition by filing separate petitions which were

docketed separately as CTA Case No. 328 and CTA Case No. 329.

It appears that on November 24, 1956, Atty. Fortunato de Leon wrote the respondent Collector the following

letter:

Sir:

This is to acknowledge receipt today of your letter of November 12, 1956, denying the

claim of Mrs. Juana F. Gonzales de Leon for refund, to which we take exception.

We are not only claiming the refund of P24,426.00 but the entire amount of P86,166.00for various reasons more specifically contained in our petition before the Court of Tax

Appeals on November 16, 1956, Case No. 328. We had to file the petition because webelieve our claim is meritorious and that the prescriptive period may run out.

For all legal purposes we shall consider your letter herein referred to as a denial of theclaim for refund of the total amount of P86,166.00. And the difference in amount may beconsidered for all purposes as variance only.

Respondent Collector, however, disclaims receipt of this second written claim for refund.

On December 5, 1956, respondent Collector contested the amended petitions. Trial ensued, and in the course

thereof the parties signed a "Partial Stipulation of Facts."

Decision. On July 16, 1958, a decision was rendered by the Court of Tax Appeals denying petitioners' claimfor refund, with costs against them. Their motion for reconsideration and new trial having been denied, petitionersperfected this appeal and now pray for reversal.

Issue. A careful perusal of the debated issues will show that the resolution of this appeal hinges decisively ontwo propositions:

(1) Whether or not petitioners' claim for refund of the total of P86,166.00 may be properly entertained;

and

(2) Whether or not the sum of P89,309.61 which each of the petitioners received as interest on the value

of the land expropriated is taxable as ordinary income, and not as capital gain.

Discussion. The record shows that on November 18, 1954, at the request of respondent Collector, the People'sHomesite and Housing Corporation turned over to the Bureau of Internal Revenue the sum of P516,007.00representing income taxes due from the six co-owners of the expropriated property. Of this amount, the twoappellants Gonzales were each credited with the amount of P86,166.00 as income taxes for 1954. (The receiptsevidencing such payments are O.R. No. 520491, dated November 19, 1954 for P86,166.00 for Jose LeonGonzales and O.R. No. 520496 dated November 19, 1954 for Juana F. Gonzales.)

It likewise appears that appellant Juana F. Gonzales in her letter of February 29, 1956, requested for the refund ofP24,426.00 (only), citing as sole ground therefor that the amount of P89,309.61 which was her share in theinterests paid on the expropriated property was taxed by respondent Collector as ordinary income. She contendedthat it should have been taxed as capital gain. Appellant Jose Leon Gonzales on his part, in his letter of November

5, 1958, requested the refund of a similar amount of P24,426.00 only.

Then a joint petition was filed by both parties before the Court of Tax Appeals first on November 15, 1956, but

the next day, November 16, 1956, they filed separate petitions containing similar allegations.

It would appear, therefore, that from November 19, 1954, when the payments for income taxes were receivedfrom the appellants to February 29, 1956, when appellant Juana Gonzales filed her claim for refund and toNovember 5, 1956, and appellant Jose Leon Gonzales filed his own refund claim, less than two years had elapsed.


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But, since their respective claims for refund were restricted to the amount of P24,426.00 only, it should be clear

that any demand for the return of an amount in excess thereof (P86,166.00) is not included.

Remarkedly, the so-called claim for refund of the amount of P86,166.00 was made onlyon November 24, 1956,(after the complaints had been filed) without giving the Collector "an opportunity to consider his mistake, ifmistake has been committed." (Kiener Co. vs. David, 92 Phil. 945) And it refers specifically and exclusively to

appellant Juana F. Gonzales' claim (Exh. "J"). Appellant Jose Leon Gonzales seems not to have filed any refundclaim for a similar amount.

Be that as it may, this later claim for refund for P86,166.00 made on November 24, 1956, by appellant Juana F.Gonzales has been definitely filed beyond the statutory period of two year, from the date of payment, which was

November 19, 1954.

A stringent requirement of the Tax Code is that before a suit or proceeding for the refund of any internal revenuetax can be maintained in any court, a written claim for its refund shall be filed with the Collector of InternalRevenue before filing the action in courtand before the expiration of two years from the date of payment of thetaxes to be refunded.3This requirement is mandatory and failure to comply therewith is fatal to the action. 4 Whatis more, the claim for refund should set forth in detail the facts and the grounds upon which it is based, so as to

apprise the Collector accordingly.5

Appellants maintain that it was not they who had paid the tax of P86,166.00 imposed upon each of them, but thatit was respondent Collector himself who paid those taxes and issued receipts therefor without their knowledge andconsent. And that even if the receipts of payment were in fact sent by the respondent Collector to the People'sHomesite and Housing Corporation and were received by the latter on November 23, 1953, said receipts could nothave been received by appellants earlier than November 28, 1954, considering that the Rules of Court treats a

service as complete only upon the expiration of five days from mailing.

We find no merit in these contentions. To begin with, there is no proof positive on record that appellant Juana F.Gonzales' so-called refund claim for the amount of P86,166.00 had been sent to, let alone received by, respondentNeither have they protested against this payment by the Collectorto the Collector. In the second place, the refundletter of November 24, 1956, assuming that it was duly filed, referred to Juana F. Gonzales' claim alone, and madeno mention of Jose Leon Gonzales'. ln the third place, the aforesaid refund claim does not set forth in detail thefacts and grounds upon which it was based and failed to apprise the respondent of her grounds for raising herclaim from P24,426.00 to P86,166.00 (see letter). Lastly, appellant Juana F. Gonzales' eleventh-hour modificationupping her refund claim from P24,426.00 to P86,166.00 was made on November 24, 1956 or eight days afterthefiling of her amended petition before the respondent court on November 16, 1956, and a few days after the two-year period.

Obviously then, the requirement ofprior timely claim for refund of the sum of P86,166.00 had not been met inthis case. The demand for refund must precede the suit, and this requirement is mandatory; so much so that non-

compliance therewith bars the action. 6

Appellants insist that payment of the tax was not made by them but by the respondent Collector himself, and that,therefore, the prescriptive period should begin not from the date of such payment but from the date appellantslearned of such payment.

This contention offers no help to appellants' cause. Assuming that appellants indeed learned of their paymentsonly on November 24, 1953, they should have claimed the refund of P86,166.00 from said date and before theyfilled their petitions with the respondent Court on November 15 or 16, 1956. Neither could they blame therespondent Collector for failing to act on their refund claims sooner for it was incumbent upon appellants to urgehim to act expeditiously on their claims, knowing as they did that the time for bringing an action for a refund ofincome tax, fixed by statute, is not extended by the delay of the Collector of Internal Revenue in giving notice of

the rejection of their claim.

Moreover, the provisions of section 306 of the Tax Code are mandatory and not subject to any qualification and,hence, they apply regardless of the conditions under which the payment has been made.8

With respect, therefore, to the issue of whether or not appellants' claim for refund of P86,166.00 (each) could now

be entertained, we believe that the same has been barred by prescription.

Anyway, it is mainly based on the proposition that our ruling in Gutierrez vs. Court of Tax Appeals, L-9738 and

L-9771, May 31, 1957, should be abandoned, a proposition we are not disposed to encourage.


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Thus, our decision will, therefore, address itself only to appellants' earlier claim for refund in the sum ofP24,426.00. Which brings us to the question of whether or not the sum of P89,309.61 which each of theappellants had received as share in the interest on the proceeds of the expropriation should be taxed as capital gain

or as ordinary income.

Appellants argue that the accessory follows the principal, that the amount paid in expropriation proceedings (the

principal, i.e., the profit thereon is admittedly capital gain, not ordinary income, and that, therefore, the interestpaid thereon (the accessory) is capital gain, not ordinary income.

This contention may not be sustained. In a previous case, 9 we held that "the acquisition by the Government ofprivate properties through the exercise of the power of eminent domain, said properties being justly compensated,is embraced within the meaning of the term 'sale' or 'disposition of property'" and the definition of gross incomelaid down by Section 29 of the Tax Code of the Philippines. We also adhered to the view that the transfer ofproperty through condemnation proceedings is a sale or exchange and that profit from the transaction constitutes

capital gain.

But to say that the proceeds of expropriation which is the return of capital and, therefore, a capital gain, partakesof the same nature as interests paid thereon is far from correct; because interest is compensation for the delay inthe return of such capital. In fact, the authorities support the conclusion that for income tax purposes, interest doesnot form part of the price paid by the Government in condemnation proceedings; and may not be treated as part ofthe capital gain. It was so held by the United States Supreme Court in Kieselback v. Commissioner of Internal

Revenue, 317 U.S. 399.

Borrowing the words and phrases of said Court, we could say now:

The sum paid these taxpayers above the award of P1,307,973.00 was paid because of the failure to put theaward in the taxpayer's hands on the day, January 25, 1947, when the property was taken. This additionalpayment was necessary to give the owners the full equivalent of the value of the property at the time itwas taken. Whether one calls it interest on the value or payments to meet the constitutional requirement ofjust compensation is immaterial. It is income paid to the taxpayers in lieu of what they might have earnedon the sum found to be the value of the property on the day the property was taken.It is not a capital gainupon an asset sold. The sale price was the P1,307,973.00.10

The property was turned over in January, 1947. This was the sale. Title then passed. The subsequent earnings ofthe property went to the Government. The transaction was as though a purchase money lien at legal interest wasretained upon the property. Such interest when paid would, of course, be ordinary income.

Incidentally, the above Supreme Court's decision disapproved the Seaside Improvement case on which petitioners

rely.

We see, therefore, no reason to impute error to the opinion of the Collector of Internal Revenue and the Court of

Tax Appeals that interest paid was ordinary income, bearing in mind that the Tax Code provides:

SEC. 29. Gross Income. General Definition. "Gross income" includes gains, profits, and incomederived from ... interests, rents, dividends, securities, or the transactions of any business carried on forgain or profit, or gains, profits and income derived from any source whatever.11

Having arrived at these conclusions, we deem it unnecessary to discuss the other points extensively argued in the

appellants' brief.

Judgment Consequently, finding no error in the appealed decision, we hereby affirm it, with costs. So ordered.


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G.R. No. L-12752 January 30, 1965

THE COLLECTOR OF INTERNAL REVENUE, petitioner,vs.

BINALBAGAN ESTATE, INC., respondent.

The Government, availing itself of its inherent power of taxation, imposed taxes on the Binalbagan Estate, Inc.,for income received by the latter corresponding to the years 1951, 1952 and 1953. Binalbagan Estate, Inc. paidsaid taxes under protest and filed before the Court of Tax Appeals an action for their refund. The Court of Tax

Appeals found for the taxpayer and the Collector of Internal Revenue brought this case before the Supreme Court.

From 1918 up to December 8, 1941 Binalbagan Estate, Inc. (Binalbagan for short), a domestic corporation.Operated a sugar central at Binalbagan, Occidental Negros, 99.5% of its capital stock was then owned by thePhilippine National Bank. Its tangible assets, with an acquisition value of P7,797,994.69 included a sugar. It

possessed a sugar quota of 296,525.856 piculs.

During World War II, Banalbagan lost its books, records and papers. 40% to 50% of its machineries, equipmentand plant was rendered useless. After the war or in 1945 it tried to reconstitute its books and records, and itsaccountant, Mr. Eugenio, assisted by two employees of the Philippines National Bank, Messrs. Cion andDomingo, undertook the work. Mr. Ramos evaluated Binalbagan's assets at P824,559.91 and accordingly entered

said amount in its newly reconstituted books. Its sugar quota was not given any value.

In 1946, upon advice of President Manuel A. Roxas and the Council of State, in order to achieve economy in therehabilitation of destroyed sugar mills and to lower the operating cost of milling sugar in the area where they werelocated, Binalbagan and Isabela Sugar Co., Inc. (Isabela for short) proposed to merge their assets to form a newcorporation to be known as Binalbagan-Isabela Sugar Co., Inc. (BISCOM for short), with a capital stock dividedinto 400,000 nonpar value shares.

To ascertain the contribution and participation of Binalbagan and Isabela in BISCOM, a committee composed of

Messrs. E. T. Westly, chairman, Raymundo Robles and Gonzalo Guillen, members, appraised the assets of bothmerging corporations. Their qualifications to undertake their work are admitted by both parties. The committeefixed the fair market value of Binalbagan's tangible assets at P2,541,134.69 and the sugar quota at P5.00 per piculor P1,482,629.28. It also pegged Isabela's tangible assets at P2,446,062.80.

On the basis of the Westly Committee's appraisal, merger was realized with Binalbagan being allocated 216,000shares of BISCOM's capital stock in exchange for its tangible assets and sugar quota. In 1948, Binalbagan gaveaway 29,055 shares to three small sugar centrals which joined BISCOM in consideration for their voting trust,thereby reducing its equity to 176,945 shares. In 1951 Binalbagan sold all the 176,945 shares to PhilippinePlanters' Investment Co. for P6,192,935.00 payable in installment. Philippines Planters' Investment Co. paidP1,500,000.00 in 1951; P350,764.47 including interest in the sum of P13,878.26 in 1953. All these receiptstogether with sundry profits and credits to surplus were reported in Binalbagan's income tax returns for 1951,

1952 and 1953. Income tax paid thereon is as follows:

1951 P14,327.00

1952 37,446.00

1953 139,617.00

For 1951, Binalbagan deducted the book value of its tangible assets in the sum of P824,559.91 (as appraised byMr. Ramos in 1945) from the initial payment of P1,500,000.00, then reported 50% of the remainder as income(gain from sale of capital assets). It claimed certain deductions which later on were found not allowable. For 1952and 1953, only 50% of the payments made by Philippine Planters' Investment Co. was returned for income tax

purposes.

On November 27, 1954 the Collector of Internal Revenue assessed against Binalbagan deficiency income tax inthe sums of P267,246.00, P36,030.00 and P127,949.00 for the years 1951, 1952 and 1953, respectively. In saidassessments, he spread over 1951, 1952 and 1953 the gain realized from the sale of Binalbagan's BISCOM sharesin accordance with Section 43 of the National Revenue Code. The Collector further considered taxable 100% ofthe gain from the sale of said BISCOM shares pursuant to Section 34 (b) of the Tax Code. Binalbagan reportedonly 50% of said gain. For 1953, he assessed in additional income tax on P3,259.60, representing miscellaneous

charges to surplus applicable to previous years.


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Binalbagan questioned the deficiency assessments but paid the same on August 18, 1955 under protest. Then itclaimed refund of P444,040.61 as overpaid income tax returns erroneously used as the cost of acquisition of itsBISCOM shares the sum of P824,559.91 1 instead of P4,023,763.97.2

Binalbagan's claim for refund having been denied, it appealed to the Court of Tax Appeals. Said court, afterhearing, found the appraisal of the Westly Committee the correct acquisition value of Binalbagan's 216,000

BISCOM shares, accordingly recomputed the income tax liability of Binalbagan and ordered the refund of theamount of P443,060.00 as overpaid income tax for the years 1951, 1952 and 1953, with legal interest thereonfrom the date of payment. Hence, this appeal of the Collector of Internal Revenue.

The issue is: How much did Binalbagan gain when it sold 176,945 nonpar value BISCOM shares to Philippine

Planters' Investment Co. in 1951?

The law in point is Section 35 of the Tax Code, which states:

SEC. 35Determination of gain or loss from the sale or other disposition of property. The gain derivedor loss sustained from the sale or other disposition of property, real, personal or mixed, shall bedetermined in accordance with the following schedule:

x x x x x x x x x

(b) In the case of property acquired on or before March first, nineteen hundred and thirteen, the costthereof if such property was acquired by purchase or the fair market price or value as of the date of

acquisition if the same was acquired by gratuitous title.

(c) In the case of exchange of one piece of property for another, the property received in exchange shallbe considered the equivalent of money in a sum equal to its fair market value on the date on which theexchange was made.

Section 35 was implemented by Section 136 of Revenue Regulations No. 2 of the Department of Finance,otherwise known as Income Tax Regulations. We quote Section 136:

SEC. 136. For the purpose of ascertaining the gain or loss from the sale or exchange of property, the basisis the cost of such property or in the case of property which should be included in the inventory, latest

inventory value.

... In any case proper adjustment must be made in computing gain or loss from the exchange or sale ofproperty for any depreciation or depletion sustained and allowable as deduction in computing net income;the amount of depreciation previously charged off by the taxpayer shall be deemed to be true depreciation

sustained unless shown by clear and convincing evidence to be incorrect.3

To determine gain or loss from the sale of the 176,945 nonpar value BISCOM shares, the basis is the acquisitioncost of said shares. Binalbagan, however, did not pay for them in cash but with its tangible assets and sugar quota.This brings us to the question value of Binalbagan's tangible assets and sugar quota as of 1946 when Binalbagan

acquired the 216,000 nonpar value shares of BISCOM in exchange therefor.

The Collector of Internal Revenue holds the view that the acquisition cost of Binalbagan's 216,000 BISCOMnonpar value shares is equivalent to the acquisition cost of the tangible assets given in exchange therefor. Suchacquisition cost amounts to P824,559.91 as determined by Mr. Ramos in 1945. How said value was arrived at,considering that Binalbagan's books and records were lost during the war, is not shown. But the Collectorindicated that Mr. Ramos made his calculation at the mill site and obtained his figures from his knowledge of theassets in question acquired by him as accountant of Binalbagan. This method of calculation suffers from theunreliability of human memory to record and recall figures with thorough exactness. Such flaw becomes apparent

when we take into account that P824,559.91 is only 10.5% of P7,797,994.69, the acquisition value of the tangibleassets in question. This appears too inadequate an estimate considering that only 40% to 50% of the said assetswere destroyed during the war.

The Collector of Internal Revenue places much emphasis on what he asserts as estoppel in pais and contends thatbecause the amount of P824,559.91 appears in Binalbagan's books, said amount should be held controlling. Wedo not find this contention material herein inasmuch as whether or not P824,559.91 is held the correct acquisitioncost of the tangible assets in question, the same would not determine the profits realized from the sale ofBinalbagan's BISCOM shares to the Philippine Planters' Investment Co. The fact remains that P824,559.91 is not


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the fair market value of said assets and, as will presently be explained, the basis in computing the taxable gainfrom the sale of Binalbagan's BISCOM shares is the fair market value of the assets and sugar quota in question.At any rate, Binalbaga's error in carrying the figure P824,559.91 in its books and using the same in its income tax

returns for 1951,1952 and 1953 neither benefited Binalbagan nor prejudiced the Government.

Binalbagan maintain that the true and correct acquisition cost of its 216,000 shares of BISCOM is equivalent to

the fair market value of its tangible assets and sugar quota as appraised by the Westly Committee. 4 This view wassustained by the Court of Tax Appeals. Considering the evidence, law and jurisprudence applicable to this case,we find the conclusion of the Court of Tax of Appeals in order.1wph1.t

There can be no doubt as to the competence of the chairman and members of the Westly Committee, all of whomwere engineers of sugar centrals and were recognized technical experts in sugar centrals and were recognizedtechnical experts in sugar central equipment and appurtenances by reason of their long experience in the sugarindustry. Precisely, to forestall overvaluation of assets by either of the merging corporations (Binalbagan andIsabela), each entity appointed one representative to the committee. The chairman, who was connected with theDel Carmen & Calamba Sugar Estate, had no relationship or privity with either of said merging corporations nor

with their respective representatives.

Assuming, however, that the acquisition cost of Binalbagan's tangible assets is P824,559.91, the value determinedby Mr. Ramos in 1945, said value may not rightly be considered the acquisition cost of the 216,000 BISCOMshares as insisted by the Collector of Internal Revenue. We are not called upon to decide the income tax due onthe profit which may have been realized by Binalbagan's when it acquired the 216,000 BISCOM shares inexchange for its tangible assets, in which case the basis would be the acquisition cost of said assets pursuant toSubsection (b), Section 35 of the Tax Code (Gutierrez vs. Court of Tax Appeals, the controversy rests onwhatever tax is imposable on the gain obtained from the sale of the 216,00 BISCOM shares to the PhilippinesPlanters' Investment Co. In short, the first transaction was in exchange, and the second was a sale. The basis indetermining the gain in such sale is the cost ofsaid shares. Inasmuch as the shares were acquired in exchange forBinalbagan's tangible assets andsugar quota, their cost is equivalent to the fair market value of said assets and

sugar quota at the time of the exchange as appraised by the Westly Committee. (Sub-section [c], Section 35 of theTax Code, afore-quoted.)

The rule has been aptly stated, thus:

... Where the consideration is property, its amount is determined by its fair market value at the time of theexchange and not by the original cost of the consideration. It is the same as if the property given inexchange had first been sold and the purchase price then immediately used to buy the property whose costbasis is under consideration. The consideration for property surrendered therein. ... The consideration forproperty received in an exchange is the value of the property surrendered. (Jacob Mertens, Jr., Law on

Federal Income Taxation, Vol. 3, Sec 21, p. 375.)

The above ruling prevails in the United States. 5 Our income tax law being of American origin, 6 the interpretationadopted by American courts on corresponding and contemporaneous provisions has peculiar persuative effect onthe interpretation of Philippine laws on the subject.

The fair market value of Binalbagan's tangible assets as appraised by the Westly Committee in the amount ofP2,541,134.69 augmented by the value of its sugar quota amounting to P1,482,629.28 is the correct acquisitioncost of the 216,000 BISCOM shares. It is, however, contended by the Collector that the value of the sugar quotaought not to be accounted as part of the acquisition cost of the BISCOM shares for the simple reason thatBinalbagan acquired them without cost. Under Subsection (c), Section 35, of the Tax Code, the acquisition cost ofthe shares of stock equivalent to the fair market value of the property given in exchange therefor. The sugar quota,which had a fair market value of P5.00 per picul, was part and parcel of the property turned over by Binalbagan toBISCOM for the 216,000 shares.

Under the terms of the contract of merger between Binalbagan and Isabela, we doubt if Binalbagan could havebeen allocated 216,000 shares without the sugar quota, or even with it, if the tangible assets of Binalbagan werevalued at only P824, 559.91. In plain language, it cost Binalbagan P2,541,134.39 worth of tangible assets andP1,482,629.28 worth of sugar quota to acquire 216,000 shares of BISCOM.

As to the method of apportioning Binalbagan's taxable gain over 1951, 1952 and 1953, there is no controversy.Under Section 43 of the Tax Code, the taxable gain or income received during the year which the gross profit

realized or to be realized when payment is completed, bears to the total contract price. The accepted formula is:


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Gross Profit

Selling PriceX Installment Received == Profit For The Year

Upon such formula, the Court of Tax Appeals computed Binalbagan's tax liability which, in addition to the tax on

sundry income, is set forth below:

1951 P64,613.00

1952 23,253.00

1953 91,419.00

Total P179,555.00==========

As Binalbagan paid a total of P622,615.00, it therefore overpaid the amount of P443,060.00 (not P444,040.61 asclaimed), which should justly be refunded to it.

The Collector has called our attention to the prescription of Binalbagan's right to the refund of the tax paid prior toMarch 22, 1954 corresponding to the years 1951 and 1952. Indeed, the right to the refund of said tax in theaggregate amount of P51,773.00 has prescribed under Section 306 of the Tax Code. Binalbagan filed its petitionfor review in the Court of Tax Appeals on March 22, 1956, more than two years from the date of payment.However, prescription has not set in to claim refund of the tax paid after March 22, 1954. The following

tabulation will clearly illustrate:

Tax Paid PriorMarch 22, 1954

Tax Paid AfterMarch 22, 1954

TotalTax Paid

1951 P14,327.00 P267,246.00 P281,573.00

1952 37,446.00 36,030.00 73,476.00

1953 127,949.00

139,617.00 267,566.00

Total P51,773.00===========

P570,842.00===========

P622,615.00===========

Accordingly, refund of P443,060.00, or any amount not exceeding P570,842.00, has not prescribed.

The Court of Tax Appeals awarded Binalbagan legal interest computed from the date the taxes were paid. There isno statutory provisions awarding interest in these cases. On several occasions, 7 we ruled that in the absence of astatutory provision clearly directing or authorizing the payment of interest. Later, however, we held that therewhere the collection of the tax sought to be refunded was attended with arbitrariness, the Commissioner ofInternal Revenue is liable to pay interest. 8 In the case at bar, collection of the deficiency income tax was notarbitrary. As a matter of fact, the figures used by the Collector in his deficiency assessment were those reportedby Binalbagan in its own income tax returns. Hence, the consequent error in the assessment was occasioned, not

by the Collector's arbitrary determination, but by the taxpayer's admitted mistake.

WHEREFORE, the Commissioner of Internal Revenue is ordered to refund to the Binalbagan Estate, Inc. theamount of P443,060.00 as overpaid income tax for the years 1951, 1952 and 1953, without interest. No costs. So

ordered.


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G.R. No. 96016 October 17, 1991

COMMISSIONER OF INTERNAL REVENUE,petitioner,-versus-

THE COURT OF APPEALS and EFREN P. CASTANEDA, respondents.

The issue to be resolved in this petition for review on certiorari is whether or not terminal leave pay received by agovernment official or employee on the occasion of his compulsory retirement from the government service is

subject to withholding (income) tax.

We resolve the issue in the negative.

Private respondent Efren P. Castaneda retired from the government service as Revenue Attache in the PhilippineEmbassy in London, England, on 10 December 1982 under the provisions of Section 12 (c) of CommonwealthAct 186, as amended. Upon retirement, he received, among other benefits, terminal leave pay from which

petitioner Commissioner of Internal Revenue withheld P12,557.13 allegedly representing income tax thereon.

Castaneda filed a formal written claim with petitioner for a refund of the P12,557.13, contending that the cashequivalent of his terminal leave is exempt from income tax. To comply with the two-year prescriptive periodwithin which claims for refund may be filed, Castaneda filed on 16 July 1984 with the Court of Tax Appeals aPetition for Review, seeking the refund of income tax withheld from his terminal leave pay.

The Court of Tax Appeals found for private respondent Castaneda and ordered the Commissioner of Internal

Revenue to refund Castaneda the sum of P12,557.13 withheld as income tax. (,Annex "C", petition).

Petitioner appealed the above-mentioned Court of Tax Appeals decision to this Court, which was docketed asG.R. No. 80320. In turn, we referred the case to the Court of Appeals for resolution. The case was docketed in theCourt of Appeals as CA-G.R. SP No. 20482.

On 26 September 1990, the Court of Appeals dismissed the petition for review and affirmed the decision of theCourt of Tax Appeals. Hence, the present recourse by the Commissioner of Internal Revenue.

The Solicitor General, acting on behalf of the Commissioner of Internal Revenue, contends that the terminal leave pay is income derived from employer-employee relationship, citing in support of his stand Section 28 of theNational Internal Revenue Code; that as part of the compensation for services rendered, terminal leave pay isactually part of gross income of the recipient. Thus

. . . It (terminal leave pay) cannot be viewed as salary for purposes which would reduce it. . . .there can thus be no "commutation of salary" when a government retiree applies for terminalleave because he is not receiving it as salary. What he applies for is a "commutation of leavecredits." It is an accumulation of credits intended for old age or separation from service. . . .

The Court has already ruled that the terminal leave pay received by a government official or employee is notsubject to withholding (income) tax. In the recent case of Jesus N. Borromeo vs. The Hon. Civil ServiceCommission, et al., G.R. No. 96032, 31 July 1991, the Court explained the rationale behind the employee's

entitlement to an exemption from withholding (income) tax on his terminal leave pay as follows:

. . . commutation of leave credits, more commonly known as terminal leave, is applied for by anofficer or employee who retires, resigns or is separated from the service through no fault of hisown. (Manual on Leave Administration Course for Effectiveness published by the Civil ServiceCommission, pages 16-17). In the exercise of sound personnel policy, the Governmentencourages unused leaves to be accumulated. The Government recognizes that for most publicservants, retirement pay is always less than generous if not meager and scrimpy. A modest nest

egg which the senior citizen may look forward to is thus avoided. Terminal leave payments aregiven not only at the same time but also for the same policy considerations governing retirementbenefits.

In fine, not being part of the gross salary or income of a government official or employee but a retirement benefit,

terminal leave pay is not subject to income tax.

ACCORDINGLY, the petition for review is hereby DENIED.SO ORDERED.


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G.R. Nos. L-28508-9 July 7, 1989

ESSO STANDARD EASTERN, INC., (formerly, Standard-Vacuum Oil Company), petitioner,vs.

THE COMMISSIONER OF INTERNAL REVENUE, respondent.

On appeal before us is the decision of the Court of Tax Appeals 1denying petitioner's claims for refundof overpaid income taxes of P102,246.00 for 1959 and P434,234.93 for 1960 in CTA Cases No. 1251and 1558 respectively.

I

In CTA Case No. 1251, petitioner ESSO deducted from its gross income for 1959, as part of its ordinaryand necessary business expenses, the amount it had spent for drilling and exploration of its petroleumconcessions. This claim was disallowed by the respondent Commissioner of Internal Revenue on theground that the expenses should be capitalized and might be written off as a loss only when a "dryhole" should result. ESSO then filed an amended return where it asked for the refund of P323,279.00by reason of its abandonment as dry holes of several of its oil wells. Also claimed as ordinary andnecessary expenses in the same return was the amount of P340,822.04, representing margin fees ithad paid to the Central Bank on its profit remittances to its New York head office.

On August 5, 1964, the CIR granted a tax credit of P221,033.00 only, disallowing the claimed deductionfor the margin fees paid.

In CTA Case No. 1558, the CR assessed ESSO a deficiency income tax for the year 1960, in theamount of P367,994.00, plus 18% interest thereon of P66,238.92 for the period from April 18,1961 to

April 18, 1964, for a total of P434,232.92. The deficiency arose from the disallowance of the marginfees of Pl,226,647.72 paid by ESSO to the Central Bank on its profit remittances to its New York headoffice.

ESSO settled this deficiency assessment on August 10, 1964, by applying the tax credit of P221,033.00representing its overpayment on its income tax for 1959 and paying under protest the additional amountof P213,201.92. On August 13, 1964, it claimed the refund of P39,787.94 as overpayment on theinterest on its deficiency income tax. It argued that the 18% interest should have been imposed not onthe total deficiency of P367,944.00 but only on the amount of P146,961.00, the difference between thetotal deficiency and its tax credit of P221,033.00.

This claim was denied by the CIR, who insisted on charging the 18% interest on the entire amount ofthe deficiency tax. On May 4,1965, the CIR also denied the claims of ESSO for refund of theoverpayment of its 1959 and 1960 income taxes, holding that the margin fees paid to the Central Bankcould not be considered taxes or allowed as deductible business expenses.

ESSO appealed to the CTA and sought the refund of P102,246.00 for 1959, contending that the marginfees were deductible from gross income either as a tax or as an ordinary and necessary businessexpense. It also claimed an overpayment of its tax by P434,232.92 in 1960, for the same reason.

Additionally, ESSO argued that even if the amount paid as margin fees were not legally deductible,there was still an overpayment by P39,787.94 for 1960, representing excess interest.

After trial, the CTA denied petitioner's claim for refund of P102,246.00 for 1959 and P434,234.92 for1960 but sustained its claim for P39,787.94 as excess interest. This portion of the decision wasappealed by the CIR but was affirmed by this Court in Commissioner of Internal Revenue v. ESSO,G.R. No. L-28502- 03, promulgated on April 18, 1989. ESSO for its part appealed the CTA decisiondenying its claims for the refund of the margin fees P102,246.00 for 1959 and P434,234.92 for 1960.

That is the issue now before us.

II

The first question we must settle is whether R.A. 2009, entitled An Act to Authorize the Central Bank ofthe Philippines to Establish a Margin Over Banks' Selling Rates of Foreign Exchange, is a policemeasure or a revenue measure. If it is a revenue measure, the margin fees paid by the petitioner to theCentral Bank on its profit remittances to its New York head office should be deductible from ESSO'sgross income under Sec. 30(c) of the National Internal Revenue Code. This provides that all taxes paid


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or accrued during or within the taxable year and which are related to the taxpayer's trade, business orprofession are deductible from gross income.

The petitioner maintains that margin fees are taxes and cites the background and legislative history ofthe Margin Fee Law showing that R.A. 2609 was nothing less than a revival of the 17% excise tax onforeign exchange imposed by R.A. 601. This was a revenue measure formally proposed by President

Carlos P. Garcia to Congress as part of, and in order to balance, the budget for 1959-1960. It wasenacted by Congress as such and, significantly, properly originated in the House of Representatives.During its two and a half years of existence, the measure was one of the major sources of revenueused to finance the ordinary operating expenditures of the government. It was, moreover, payable outof the General Fund.

On the claimed legislative intent, the Court of Tax Appeals, quoting established principles, pointed outthat

We are not unmindful of the rule that opinions expressed in debates, actual proceedings of thelegislature, steps taken in the enactment of a law, or the history of the passage of the law through thelegislature, may be resorted to as an aid in the interpretation of a statute which is ambiguous or ofdoubtful meaning. The courts may take into consideration the facts leading up to, coincident with, andin any way connected with, the passage of the act, in order that they may properly interpret thelegislative intent. But it is also well-settled jurisprudence that only in extremely doubtful matters ofinterpretation does the legislative history of an act of Congress become important. As a matter of fact,there may be no resort to the legislative history of the enactment of a statute, the language of which isplain and unambiguous, since such legislative history may only be resorted to for the purpose of solvingdoubt, not for the purpose of creating it. [50 Am. Jur. 328.]

Apart from the above consideration, there are at least two cases where we have held that a margin feeis not a tax but an exaction designed to curb the excessive demands upon our international reserve.

In Caltex (Phil.) Inc. v. Acting Commissioner of Customs, 2 the Court stated through Justice Jose P.Bengzon:

A margin levy on foreign exchange is a form of exchange control or restriction designedto discourage imports and encourage exports, and ultimately, 'curtail any excessivedemand upon the international reserve' in order to stabilize the currency. Originallyadopted to cope with balance of payment pressures, exchange restrictions have come toserve various purposes, such as limiting non-essential imports, protecting domesticindustry and when combined with the use of multiple currency rates providing a sourceof revenue to the government, and are in many developing countries regarded as a moreor less inevitable concomitant of their economic development programs. The differentmeasures of exchange control or restriction cover different phases of foreign exchangetransactions, i.e., in quantitative restriction, the control is on the amount of foreignexchange allowable. In the case of the margin levy, the immediate impact is on the rateof foreign exchange; in fact, its main function is to control the exchange rate withoutchanging the par value of the peso as fixed in the Bretton Woods Agreement Act. For amember nation is not supposed to alter its exchange rate (at par value) to correct amerely temporary disequilibrium in its balance of payments. By its nature, the marginlevy is part of the rate of exchange as fixed by the government.

As to the contention that the margin levy is a tax on the purchase of foreign exchange and henceshould not form part of the exchange rate, suffice it to state that We have already held the contrary forthe reason that a tax is levied to provide revenue for government operations, while the proceeds of themargin fee are applied to strengthen our country's international reserves.

Earlier, in Chamber of Agriculture and Natural Resources of the Philippines v. Central Bank,3 the same

idea was expressed, though in connection with a different levy, through Justice J.B.L. Reyes:

Neither do we find merit in the argument that the 20% retention of exporter's foreignexchange constitutes an export tax. A tax is a levy for the purpose of providing revenuefor government operations, while the proceeds of the 20% retention, as we have seen,are applied to strengthen the Central Bank's international reserve.


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We conclude then that the margin fee was imposed by the State in the exercise of its police power andnot the power of taxation.

Alternatively, ESSO prays that if margin fees are not taxes, they should nevertheless be considerednecessary and ordinary business expenses and therefore still deductible from its gross income. Thefees were paid for the remittance by ESSO as part of the profits to the head office in the Unites States.

Such remittance was an expenditure necessary and proper for the conduct of its corporate affairs.

The applicable provision is Section 30(a) of the National Internal Revenue Code reading as follows:

SEC. 30. Deductions from gross income in computing net income there shall be allowedas deductions

(a) Expenses:

(1) In general. All the ordinary and necessary expenses paid or incurred during thetaxable year in carrying on any trade or business, including a reasonable allowance for

salaries or other compensation for personal services actually rendered; travelingexpenses while away from home in the pursuit of a trade or business; and rentals orother payments required to be made as a condition to the continued use or possession,for the purpose of the trade or business, of property to which the taxpayer has not takenor is not taking title or in which he has no equity.

(2) Expenses allowable to non-resident alien individuals and foreign corporations. Inthe case of a non-resident alien individual or a foreign corporation, the expensesdeductible are the necessary expenses paid or incurred in carrying on any business ortrade conducted within the Philippines exclusively.

In the case of Atlas Consolidated Mining and Development Corporation v. Commissioner of Internal

Revenue,

4

the Court laid down the rules on the deductibility of business expenses, thus:

The principle is recognized that when a taxpayer claims a deduction, he must point tosome specific provision of the statute in which that deduction is authorized and must beable to prove that he is entitled to the deduction which the law allows. As previouslyadverted to, the law allowing expenses as deduction from gross income for purposes ofthe income tax is Section 30(a) (1) of the National Internal Revenue which allows adeduction of 'all the ordinary and necessary expenses paid or incurred during the taxableyear in carrying on any trade or business.' An item of expenditure, in order to bedeductible under this section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to be

deductible as a business expense, three conditions are imposed, namely: (1) theexpense must be ordinary and necessary, (2) it must be paid or incurred within thetaxable year, and (3) it must be paid or incurred in carrying on a trade or business. Inaddition, not only must the taxpayer meet the business test, he must substantially proveby evidence or records the deductions claimed under the law, otherwise, the same willbe disallowed. The mere allegation of the taxpayer that an item of expense is ordinaryand necessary does not justify its deduction.

While it is true that there is a number of decisions in the United States delving on theinterpretation of the terms 'ordinary and necessary' as used in the federal tax laws, noadequate or satisfactory definition of those terms is possible. Similarly, this Court hasnever attempted to define with precision the terms 'ordinary and necessary.' There are

however, certain guiding principles worthy of serious consideration in the properadjudication of conflicting claims. Ordinarily, an expense will be considered 'necessary'where the expenditure is appropriate and helpful in the development of the taxpayer'sbusiness. It is 'ordinary' when it connotes a payment which is normal in relation to thebusiness of the taxpayer and the surrounding circumstances. The term 'ordinary' doesnot require that the payments be habitual or normal in the sense that the same taxpayerwill have to make them often; the payment may be unique or non-recurring to theparticular taxpayer affected.


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There is thus no hard and fast rule on the matter. The right to a deduction depends ineach case on the particular facts and the relation of the payment to the type of businessin which the taxpayer is engaged. The intention of the taxpayer often may be thecontrolling fact in making the determination. Assuming that the expenditure is ordinaryand necessary in the operation of the taxpayer's business, the answer to the question asto whether the expenditure is an allowable deduction as a business expense must be

determined from the nature of the expenditure itself, which in turn depends on the extentand permanency of the work accomplished by the expenditure.

In the light of the above explanation, we hold that the Court of Tax Appeals did not err when it held onthis issue as follows:

Considering the foregoing test of what constitutes an ordinary and necessary deductibleexpense, it may be asked: Were the margin fees paid by petitioner on its profitremittance to its Head Office in New York appropriate and helpful in the taxpayer'sbusiness in the Philippines? Were the margin fees incurred for purposes proper to theconduct of the affairs of petitioner's branch in the Philippines? Or were the margin feesincurred for the purpose of realizing a profit or of minimizing a loss in the Philippines?

Obviously not. As stated in the Lopez case, the margin fees are not expenses inconnection with the production or earning of petitioner's incomes in the Philippines. Theywere expenses incurred in the disposition of said incomes; expenses for the remittanceof funds after they have already been earned by petitioner's branch in the Philippines forthe disposal of its Head Office in New York which is already another distinct andseparate income taxpayer.

x x x

Since the margin fees in question were incurred for the remittance of funds to petitioner'sHead Office in New York, which is a separate and distinct income taxpayer from thebranch in the Philippines, for its disposal abroad, it can never be said therefore that themargin fees were appropriate and helpful in the development of petitioner's business inthe Philippines exclusively or were incurred for purposes proper to the conduct of theaffairs of petitioner's branch in the Philippines exclusively or for the purpose of realizinga profit or of minimizing a loss in the Philippines exclusively. If at all, the margin feeswere incurred for purposes proper to the conduct of the corporate affairs of StandardVacuum Oil Company in New York, but certainly not in the Philippines.

ESSO has not shown that the remittance to the head office of part of its profits was made in furtheranceof its own trade or business. The petitioner merely presumed that all corporate expenses are necessaryand appropriate in the absence of a showing that they are illegal orultra vires. This is error. The publicrespondent is correct when it asserts that "the paramount rule is that claims for deductions are a matterof legislative grace and do not turn on mere equitable considerations ... . The taxpayer in everyinstance has the burden of justifying the allowance of any deduction claimed." 5

It is clear that ESSO, having assumed an expense properly attributable to its head office, cannot nowclaim this as an ordinary and necessary expense paid or incurred in carrying on its own trade orbusiness.

WHEREFORE, the decision of the Court of Tax Appeals denying the petitioner's claims for refund ofP102,246.00 for 1959 and P434,234.92 for 1960, is AFFIRMED, with costs against the petitioner.

SOORDERED.


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G.R. No. L-24248 July 31, 1974

ANTONIO TUASON, JR.,petitioner,-versus-

JOSE B. LINGAD, as Commissioner of Internal Revenue, respondent.

In this petition for review of the decision of the Court of Tax Appeals in CTA Case 1398, the petitioner AntonioTuason, Jr. (hereinafter referred to as the petitioner) assails the Tax Court's conclusion that the gains he realizedfrom the sale of residential lots (inherited from his mother) were ordinary gains and not gains from the sale of

capital assets under section 34(1) of the National Internal Revenue Code.

The essential facts are not in dispute.

In 1948 the petitioner inherited from his mother several tracts of land, among which were two contiguous parcelssituated on Pureza and Sta. Mesa streets in Manila, with an area of 318 and 67,684 square meters, respectively.

When the petitioner's mother was yet alive she had these two parcels subdivided into twenty-nine lots. Twenty-

eight were allocated to their then occupants who had lease contracts with the petitioner's predecessor at varioustimes from 1900 to 1903, which contracts expired on December 31, 1953. The 29th lot (hereinafter referred to asLot 29), with an area of 48,000 square meters, more or less, was not leased to any person. It needed fillingbecause of its very low elevation, and was planted to kangkongand other crops.

After the petitioner took possession of the mentioned parcels in 1950, he instructed his attorney-in-fact, J. Antonio

Araneta, to sell them.

There was no difficulty encountered in selling the 28 small lots as their respective occupants bought them on a 10-

year installment basis. Lot 29 could not however be sold immediately due to its low elevation.

Sometime in 1952 the petitioner's attorney-in-fact had Lot 29 filled, then subdivided into small lots and paved

with macadam roads. The small lots were then sold over the years on a uniform 10-year annual amortizationbasis. J. Antonio Araneta, the petitioner's attorney-in-fact, did not employ any broker nor did he put up

advertisements in the matter of the sale thereof.

In 1953 and 1954 the petitioner reported his income from the sale of the small lots (P102,050.79 and P103,468.56,respectively) as long-term capital gains. On May 17, 1957 the Collector of Internal Revenue upheld thepetitioner's treatment of his gains from the said sale of small lots, against a contrary ruling of a revenue examiner.

In his 1957 tax return the petitioner as before treated his income from the sale of the small lots (P119,072.18) ascapital gains and included only thereof as taxable income. In this return, the petitioner deducted the real estatedealer's tax he paid for 1957. It was explained, however, that the payment of the dealer's tax was on account ofrentals received from the mentioned 28 lots and other properties of the petitioner. On the basis of the 1957

opinion of the Collector of Internal Revenue, the revenue examiner approved the petitioner's treatment of hisincome from the sale of the lots in question. In a memorandum dated July 16, 1962 to the Commissioner ofInternal Revenue, the chief of the BIR Assessment Department advanced the same opinion, which was concurredin by the Commissioner of Internal Revenue.

On January 9, 1963, however, the Commissioner reversed himself and considered the petitioner's profits from thesales of the mentioned lots as ordinary gains. On January 28, 1963 the petitioner received a letter from the Bureau

of Internal Revenue advising him to pay deficiency income tax for 1957, as follows:

Net income per orig. investigation ............... P211,095.36Add:56% of realized profit on sale

of lots which was deducted in theincome tax return and allowed inthe original report of examination ................. 59,539.09 Net income per final investigation .................

P270,824.70

Less: Personal exemption ..................................... 1,800.00Amount subject to tax ................................. P269,024.70 Tax due thereon ..........................................

P98,551.00


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Less: Amount already assessed .................... 72,199.00 Balance ......... P26,352.00

Add:% monthly interest from6-20-59 to 6-29-62 .................................... 4,742.36

TOTAL AMOUNT DUE ANDCOLLECTIBLE ......................................... P31,095.36

The petitioner's motion for reconsideration of the foregoing deficiency assessment was denied, and so he went upto the Court of Tax Appeals, which however rejected his posture in a decision dated January 16, 1965, andordered him, in addition, to pay a 5% Surcharge and 1% monthly interest "pursuant to Sec. 51(e) of the Revenue

Code."

Hence, the present petition.

The petitioner assails the correctness of the opinion below that as he was engaged in the business of leasing thelots he inherited from his mother as well other real properties, his subsequent sales of the mentioned lots cannotbe recognized as sales of capital assets but of "real property used in trade or business of the taxpayer." Thepetitioner argues that (1) he is not the one who leased the lots in question; (2) the lots were residential, notcommercial lots; and (3) the leases on the 28 small lots were to last until 1953, before which date he waspowerless to eject the lessees therefrom.

The basic issue thus raised is whether the properties in question which the petitioner had inherited and

subsequently sold in small lots to other persons should be regarded as capital assets.

1. The National Internal Revenue Code (C.A. 466, as amended) defines the term "capital assets" as follows:

(1) Capital assets. The term "capital assets" means property held by the taxpayer (whether or

not connected with his trade or business), but does not include stock in trade of the taxpayer orother property of a kind which would properly be included in the inventory of the taxpayer if onhand at the close of the taxable year, or property held by the taxpayer primarily for sale tocustomers in the ordinary course of his trade or business, or property, used in the trade orbusiness, of a character which is subject to the allowance for depreciation provided in subsection(f) of section thirty; or real property used in the trade or business of the taxpayer.

As thus defined by law, the term "capital assets" includes all the properties of a taxpayer whether or not connectedwith his trade or business, except: (1) stock in trade or other property included in the taxpayer's inventory; (2)property primarily for sale to customers in the ordinary course of his trade or business; (3) property used in thetrade or business of the taxpayer and subject to depreciation allowance; and (4) real property used in trade orbusiness. 1If the taxpayer sells or exchanges any of the properties above-enumerated, any gain or loss relative

thereto is an ordinary gain or an ordinary loss; the gain or loss from the sale or exchange of all other properties ofthe taxpayer is a capital gain or a capital loss. 2

Under section 34(b) (2) of the Tax Code, if a gain is realized by a taxpayer (other than a corporation) from thesale or exchange of capital assets held for more than twelve months, only 50% of the net capital gain shall be

taken into account in computing the net income.

The Tax Code's provision on so-called long-term capital gains constitutes a statute of partial exemption. In viewof the familiar and settled rule that tax exemptions are construed instrictissimi juris against the taxpayer andliberally in favor of the taxing authority, 3the field of application of the term it "capital assets" is necessarilynarrow, while its exclusions must be interpreted broadly. 4Consequently, it is the taxpayer's burden to bringhimself clearly and squarely within the terms of a tax-exempting statutory provision, otherwise, all fair doubts

will be resolved against him.5

It bears emphasis nonetheless that in the determination of whether a piece ofproperty is a capital asset or an ordinary asset, a careful examination and weighing of all circumstances revealedin each case must be made. 6

In the case at bar, after a thoroughgoing study of all the circumstances relevant to the resolution of the issue

raised, this Court is of the view, and so holds, that the petitioner's thesis is bereft of merit.

When the petitioner obtained by inheritance the parcels in question, transferred to him was not merely the duty torespect the terms of any contract thereon, but as well the correlative right to receive and enjoy the fruits of the


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business and property which the decedent had established and maintained. 7Moreover, the record discloses thatthe petitioner owned other real properties which he was putting out for rent, from which he periodically derived asubstantial income, and for which he had to pay the real estate dealer's tax (which he used to deduct from hisgross income). 8In fact, as far back as 1957 the petitioner was receiving rental payments from the mentioned 28small lots, even if the leases executed by his deceased mother thereon expired in 1953. Under the circumstances,the petitioner's sales of the several lots forming part of his rental business cannot be characterized as other than

sales of non-capital assets.

The sales concluded on installment basis of the subdivided lots comprising Lot 29 do not deserve a differentcharacterization for tax purposes. The following circumstances in combination show unequivocally that thepetitioner was, at the time material to this case, engaged in the real estate business: (1) the parcels of landinvolved have in totality a substantially large area, nearly seven (7) hectares, big enough to be transformed into asubdivision, and in the case at bar, the said properties are located in the heart of Metropolitan Manila; (2) theywere subdivided into small lots and then sold on installment basis (this manner of selling residential lots is one ofthe basic earmarks of a real estate business); (3) comparatively valuable improvements were introduced in thesubdivided lots for the unmistakable purpose of not simply liquidating the estate but of making the lots moresaleable to the general public; (4) the employment of J. Antonio Araneta, the petitioner's attorney-in-fact, for thepurpose of developing, managing, administering and selling the lots in question indicates the existence of owner-

realty broker relationship; (5) the sales were made with frequency and continuity, and from these the petitionerconsequently received substantial income periodically; (6) the annual sales volume of the petitioner from the saidlots was considerable, e.g., P102,050.79 in 1953; P103,468.56 in 1954; and P119,072.18 in 1957; and (7) thepetitioner, by his own tax returns, was not a person who can be indubitably adjudged as a stranger to the realestate business. Under the circumstances, this Court finds no error in the holding below that the income of the

petitioner from the sales of the lots in question should be considered as ordinary income.

2. This Court notes, however, that in ordering the petitioner to pay the deficiency income tax, the Tax Court alsorequired him to pay a 5% surcharge plus 1% monthly interest. In our opinion this additional requirement shouldbe eliminated because the petitioner relied in good faith upon opinions rendered by no less than the highestofficials of the Bureau of Internal Revenue, including the Commissioner himself. The following ruling in Connell

Bros. Co. (Phil.) vs. Collector of Internal Revenue 9applies with reason to the case at bar:

We do not think Section 183(a) of the National Internal Revenue Code is applicable. The sameimposes the penalty of 25% when the percentage tax is not paid on time, and contemplates a casewhere the liability for the tax is undisputed or indisputable. In the present case the taxes werepaid, the delay being with reference to the deficiency, owing to a controversy as to the properinterpretation if Circulars Nos. 431 and 440 of the office of respondent-appellee. The controversywas generated in good faith, since that office itself appears to have formerly taken the view thatthe inclusion of the words "tax included" on invoices issued by the taxpayer was sufficient

compliance with the requirements of said circulars. 10

ACCORDINGLY, the judgment of the Court of Tax Appeals is affirmed, except the portion thereof that imposes5% surcharge and 1% monthly interest, which is hereby set aside. No costs.


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G.R. No. L-26284 October 8, 1986

TOMAS CALASANZ, ET AL., petitioners,vs.THE COMMISSIONER OF INTERNAL REVENUE and the COURT OF TAX APPEALS, respondents.

Appeal taken by Spouses Tomas and Ursula Calasanz from the decision of the Court of Tax Appeals inCTA No. 1275 dated June 7, 1966, holding them liable for the payment of P3,561.24 as deficiencyincome tax and interest for the calendar year 1957 and P150.00 as real estate dealer's fixed tax.

Petitioner Ursula Calasanz inherited from her father Mariano de Torres an agricultural land located inCainta, Rizal, containing a total area of 1,678,000 square meters. In order to liquidate her inheritance,Ursula Calasanz had the land surveyed and subdivided into lots. Improvements, such as good roads,concrete gutters, drainage and lighting system, were introduced to make the lots saleable. Soon after,the lots were sold to the public at a profit.

In their joint income tax return for the year 1957 filed with the Bureau ofInternal Revenue on March 31,1958, petitioners disclosed a profit of P31,060.06 realized from the sale of the subdivided lots, andreported fifty per centum thereof or P15,530.03 as taxable capital gains.

Upon an audit and review of the return thus filed, the Revenue Examiner adjudged petitioners engagedin business as real estate dealers, as defined in Section 194 [s] 1 of the National Internal RevenueCode, required them to pay the real estate dealer's tax 2 and assessed a deficiency income tax onprofits derived from the sale of the lots based on the rates for ordinary income.

On September 29, 1962, petitioners received from respondent Commissioner ofInternal Revenue:

a. Demand No. 90-B-032293-57 in the amount of P160.00 representing real estatedealer's fixed tax of P150.00 and P10.00 compromise penalty for late payment; and

b. Assessment No. 90-5-35699 in the amount of P3,561.24 as deficiency income tax onordinary gain of P3,018.00 plus interest of P 543.24.

On October 17, 1962, petitioners filed with the Court of Tax Appeals a petition for review contesting theaforementioned assessments.

On June 7, 1966, the Tax Court upheld the respondent Commissioner except for that portion of theassessment regarding the compromise penalty of P10.00 for the reason that in this jurisdiction, thesame cannot be collected in the absence of a valid and binding compromise agreement.

Hence, the present appeal.

The issues for consideration are:

a. Whether or not petitioners are real estate dealers liable for real estate dealer's fixedtax; and

b. Whether the gains realized from the sale of the lots are taxable in full as ordinaryincome or capital gains taxable at capital gain rates.

The issues are closely interrelated and will be taken jointly.

Petitioners assail their liabilities as "real estate dealers" and seek to bring the profits from the sale ofthe lots under Section 34 [b] [2] 3 of the Tax Code.

The theory advanced by the petitioners is that inherited land is a capital asset within the meaning ofSection 34[a] [1] of the Tax Code and that an heir who liquidated his inheritance cannot be said to haveengaged in the real estate business and may not be denied the preferential tax treatment given to gainsfrom sale of capital assets, merely because he disposed of it in the only possible and advantageousway.


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Petitioners averred that the tract of land subject of the controversy was sold because of their intentionto effect a liquidation. They claimed that it was parcelled out into smaller lots because its size proveddifficult, if not impossible, of disposition in one single transaction. They pointed out that oncesubdivided, certainly, the lots cannot be sold in one isolated transaction. Petitioners, however, admittedthat roads and other improvements were introduced to facilitate its sale. 4

On the other hand, respondent Commissioner maintained that the imposition of the taxes in question isin accordance with law since petitioners are deemed to be in the real estate business for having beeninvolved in a series of real estate transactions pursued for profit. Respondent argued that propertyacquired by inheritance may be converted from an investment property to a business property if, as inthe present case, it was subdivided, improved, and subsequently sold and the number, continuity andfrequency of the sales were such as to constitute "doing business." Respondent likewise contendedthat inherited property is by itself neutral and the fact that the ultimate purpose is to liquidate is of nomoment for the important inquiry is what the taxpayer did with the property. Respondent concluded thatsince the lots are ordinary assets, the profits realized therefrom are ordinary gains, hence taxable infull.

We agree with the respondent.

The assets of a taxpayer are classified for income tax purposes into ordinary assets and capital assets.Section 34[a] [1] of the National Internal Revenue Code broadly defines capital assets as follows:

[1] Capital assets.-The term 'capital assets' means property held by the taxpayer[whether or not connected with his trade or business], but does not include, stock intrade of the taxpayer or other property of a kind which would properly be included, in theinventory of the taxpayer if on hand at the close of the taxable year, or property held bythe taxpayer primarily for sale to customers in the ordinary course of his trade orbusiness, or property used in the trade or business of a character which is subject to theallowance for depreciation provided in subsection [f] of section thirty; or real propertyused in the trade or business of the taxpayer.

The statutory definition of capital assets is negative in nature. 5If the asset is not among theexceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets.

And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or anordinary gain depending on the kind of asset involved in the transaction.

However, there is no rigid rule or fixed formula by which it can be determined with finality whetherproperty sold by a taxpayer was held primarily for sale to customers in the ordinary course of his tradeor business or whether it was sold as a capital asset. 6 Although several factors or indices 7 have beenrecognized as helpful guides in making a determination, none of these is decisive; neither is thepresence nor the absence of these factors conclusive. Each case must in the last analysis rest upon itsown peculiar facts and circumstances. 8

Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if acombination of the factors indubitably tend to show that the activity was in furtherance of or in thecourse of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capitalgain or loss even though the property has to be subdivided or improved or both to make it salable.However, if the inherited property is substantially improved or very actively sold or both it may betreated as held primarily for sale to customers in the ordinary course of the heir's business. 9

Upon an examination of the facts on record, We are convinced that the activities of petitioners areindistinguishable from those invariably employed by one engaged in the business of selling real estate.

One strong factor against petitioners' contention is the business element of development which is verymuch in evidence. Petitioners did not sell the land in the condition in which they acquired it. While theland was originally devoted to rice and fruit trees, 10 it was subdivided into small lots and in the processconverted into a residential subdivision and given the name Don Mariano Subdivision. Extensiveimprovements like the laying out of streets, construction of concrete gutters and installation of lightingsystem and drainage facilities, among others, were undertaken to enhance the value of the lots andmake them more attractive to prospective buyers. The audited financial statements 11 submittedtogether with the tax return in question disclosed that a considerable amount was expended to coverthe cost of improvements. As a matter of fact, the estimated improvements of the lots sold reachedP170,028.60 whereas the cost of the land is only P 4,742.66. There is authority that a property ceases


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to be a capital asset if the amount expended to improve it is double its original cost, for the extensiveimprovement indicates that the seller held the property primarily for sale to customers in the ordinarycourse of his business. 12

Another distinctive feature of the real estate business discernible from the records is the existence ofcontracts receivables, which stood at P395,693.35 as of the year ended December 31, 1957. The

sizable amount of receivables in comparison with the sales volume of P446,407.00 during the sameperiod signifies that the lots were sold on installment basis and suggests the number, continuity andfrequency of the sales. Also of significance is the circumstance that the lots were advertised 13 for sale

to the public and that sales and collection commissions were paid out during the period in question.

Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.

In Ehrman vs. Commissioner, 14the American court in clear and categorical terms rejected theliquidation test in determining whether or not a taxpayer is carrying on a trade or business The courtobserved that the fact that property is sold for purposes of liquidation does not foreclose adetermination that a "trade or business" is being conducted by the seller. The court enunciated further:

We fail to see that the reasons behind a person's entering into a business-whether it is tomake money or whether it is to liquidate-should be determinative of the question ofwhether or not the gains resulting from the sales are ordinary gains or capital gains. Thesole question is-were the taxpayers in the business of subdividing real estate? If theywere, then it seems indisputable that the property sold falls within the exception in thedefinition of capital assets . . . that is, that it constituted 'property held by the taxpayerprimarily for sale to customers in the ordinary course of his trade or business.

Additionally, in Home Co., Inc. vs. Commissioner,15 the court articulated on the matter in this wise:

One may, of course, liquidate a capital asset. To do so, it is necessary to sell. The sale

may be conducted in the most advantageous manner to the seller and he will not losethe benefits of the capital gain provision of the statute unless he enters the real estatebusiness and carries on the sale in the manner in which such a business is ordinarilyconducted. In that event, the liquidation constitutes a business and a sale in the ordinarycourse of such a business and the preferred tax status is lost.

In view of the foregoing, We hold that in the course of selling the subdivided lots, petitioners engaged inthe real estate business and accordingly, the gains from the sale of the lots are ordinary income taxablein full.

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

SOORDERED.


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

FERNANDEZ HERMANOS, INC., petitioner,-versus-

COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.

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


COMMISSIONER OF INTERNAL REVENUE, petitioner,-versus-

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

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


COMMISSIONER OF INTERNAL REVENUE, petitioner,-versus-

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

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


FERNANDEZ HERMANOS, INC., petitioner,-versus-

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

APPEALS, respondents.

L-21551:

Rafael Dinglasan for petitioner.Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong and Special Attorney Virgilio G.

Saldajeno for respondent.

L-21557:

Office of the Solicitor General for petitioner.

Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

L-24972:

Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and SpecialAttorney Virgilio G. Saldajeno for petitioner.

Rafael Dinglasan for respondent Fernandez Hermanos, Inc.

L-24978:

Rafael Dinglasan for petitioner.Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Antonio G. Ibarra and Special

Attorney Virgilio G. Saldajeno for respondent.

TEEHANKEE, J.:

These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's incometax liability for the years 1950 to 1954 and for the year 1957. Both the taxpayer and the Commissioner of InternalRevenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax Court's decisions,


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RESUME

1950 P2,748.00

1951 108,724.00

1952 3,600.00

1953 2,501.001954 5,863.00

Total P123,436.00

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

Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision.Two main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to thedisputed items of disallowances enumerated in the Tax Court's summary reproduced above, and second, whether

or not the government's right to collect the deficiency income taxes in question has already prescribed.

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

1.Re allowances/disallowances of losses.

(a)Allowance of losses in Mati Lumber Co. (1950). The Commissioner of Internal Revenue questionsthe Tax Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum ofP8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1,

1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly established. TheCommissioner contends that although the said Company was no longer in operation in 1950, it still had itssawmill and equipment which must be of considerable value. The Court, however, found that "the companyceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where hesubsequently died. When the company eased to operate, it had no assets, in other words, completely insolvent.This information as to the insolvency of the Company reached (the taxpayer) in 1950," when it properlyclaimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30 (e) (3) of the

National Internal Revenue Code. 2

We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off ofthe stock as worthless securities. Assuming that the Company would later somehow realize some proceeds fromits sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds

would later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer wouldthen properly be reportable as income of the taxpayer in the year it is received.

(b)Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). The taxpayerappeals from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of P353,134.25,

which it had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings on this item follow:

Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are alsothe controlling stockholders of petitioner corporation, requested financial help from petitioner to enable itto resume it mining operations in Coron, Palawan. The request for financial assistance was readily andunanimously approved by the Board of Directors of petitioner, and thereafter a memorandum agreementwas executed on August 12, 1945, embodying the terms and conditions under which the financial

assistance was to be extended, the pertinent provisions of which are as follows:

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

Fernandez to cause the release of funds to the SECOND PARTY.


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

"NOW THEREFORE, for and in consideration of the above premises, the parties heretohave agreed and covenanted that in consideration of the financial help to be extended by the

FIRST PARTY to the SECOND PARTY to enable the latter to resume its mining operations inCoron, Palawan, the SECOND PARTY has agreed and undertaken as it hereby agrees andundertakes to pay to the FIRST PARTY fifteen per centum (15%) of its net profits." (Exh. H-2)

Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearlyadvances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite theseadvances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses. By1951, petitioner became convinced that those advances could no longer be recovered. While it continued to giveadvances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on the basis ofthe total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the sum ofP85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136-139,Id)." (Page 4,Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950 and 1951 in the hope that

it might be able to recover the same, as in fact it continued to give advances up to 1952. From these facts, and asadmitted by petitioner itself, Palawan Manganese Mines, Inc., was still in operation when the advancescorresponding to the years 1945 to 1949 were written off the books of petitioner. Under the circumstances, wasthe sum of P353,134.25 properly claimed by petitioner as deduction in its income tax return for 1951, either as

losses or bad debts?

It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to berepaid. It is true that some testimonial evidence was presented to show that there was some agreement that theadvances would be repaid, but no documentary evidence was presented to this effect. The memorandumagreement signed by the parties appears to be very clear that the consideration for the advances made by petitionerwas 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no earnings or profits,there was no obligation to repay those advances. It has been held that the voluntary advances made without

expectation of repayment do not result in deductible losses. 1955 PH Fed. Taxes, Par. 13, 329, citing W. F. Young,Inc. v. Comm., 120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC. 1593.

Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to PalawanManganese Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under thememorandum agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner 15% of

its net profits, not the advances. No bad debt could arise where there is no valid and subsisting debt.

Again, assuming that in this case there was a valid and subsisting

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