Republic of the Philippines

SUPREME COURT
Manila
FIRST DIVISION

G.R. No. L-27044 June 30, 1975

THE COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
ENGINEERING EQUIPMENT AND SUPPLY COMPANY AND THE
COURT OF TAX APPEALS, respondents.
G.R. No. L-27452 June 30, 1975
ENGINEERING EQUIPMENT AND SUPPLY COMPANY, petitioner,
vs.
THE COMMISSIONER OF INTERNAL REVENUE AND THE COURT OF
TAX APPEALS, respondent.

ESGUERRA, J.:
Petition for review on certiorari of the decision of the Court of Tax Appeals
in CTA Case No. 681, dated November 29, 1966, assessing a
compensating tax of P174,441.62 on the Engineering Equipment and
Supply Company.
As found by the Court of Tax Appeals, and as established by the evidence
on record, the facts of this case are as follows:
Engineering Equipment and Supply Co. (Engineering for short), a domestic
corporation, is an engineering and machinery firm. As operator of an
integrated engineering shop, it is engaged, among others, in the design
and installation of central type air conditioning system, pumping plants and
steel fabrications. (Vol. I pp. 12-16 T.S.N. August 23, 1960)

On July 27, 1956, one Juan de la Cruz, wrote the then Collector, now
Commissioner, of Internal Revenue denouncing Engineering for tax
evasion by misdeclaring its imported articles and failing to pay the correct
percentage taxes due thereon in connivance with its foreign suppliers
(Exh. "2" p. 1 BIR record Vol. I). Engineering was likewise denounced to
the Central Bank (CB) for alleged fraud in obtaining its dollar allocations.
Acting on these denunciations, a raid and search was conducted by a joint
team of Central Bank, (CB), National Bureau of Investigation (NBI) and
Bureau of Internal Revenue (BIR) agents on September 27, 1956, on
which occasion voluminous records of the firm were seized and
confiscated. (pp. 173-177 T.S.N.)
On September 30, 1957, revenue examiners Quesada and Catudan
reported and recommended to the then Collector, now Commissioner, of
Internal Revenue (hereinafter referred to as Commissioner) that
Engineering be assessed for P480,912.01 as deficiency advance sales tax
on the theory that it misdeclared its importation of air conditioning units
and parts and accessories thereof which are subject to tax under Section
185(m) 1 of the Tax Code, instead of Section 186 of the same Code. (Exh.
"3" pp. 59-63 BIR rec. Vol. I) This assessment was revised on January 23,
1959, in line with the observation of the Chief, BIR Law Division, and was
raised to P916,362.56 representing deficiency advance sales tax and
manufacturers sales tax, inclusive of the 25% and 50% surcharges. (pp.
72-80 BIR rec. Vol. I)
On March 3, 1959. the Commissioner assessed against, and demanded
upon, Engineering payment of the increased amount and suggested that
P10,000 be paid as compromise in extrajudicial settlement of
Engineering's penal liability for violation of the Tax Code. The firm,
however, contested the tax assessment and requested that it be furnished
with the details and particulars of the Commissioner's assessment. (Exh.
"B" and "15", pp. 86-88 BIR rec. Vol. I) The Commissioner replied that the
assessment was in accordance with law and the facts of the case.
On July 30, 1959, Engineering appealed the case to the Court of Tax
Appeals and during the pendency of the case the investigating revenue
examiners reduced Engineering's deficiency tax liabilities from
P916,362.65 to P740,587.86 (Exhs. "R" and "9" pp. 162-170, BIR rec.),
based on findings after conferences had with Engineering's Accountant
and Auditor.

On November 29, 1966, the Court of Tax Appeals rendered its decision,
the dispositive portion of which reads as follows:
For ALL THE FOREGOING CONSIDERATIONS, the
decision of respondent appealed from is hereby modified,
and petitioner, as a contractor, is declared exempt from
the deficiency manufacturers sales tax covering the period
from June 1, 1948. to September 2, 1956. However,
petitioner is ordered to pay respondent, or his duly
authorized collection agent, the sum of P174,141.62 as
compensating tax and 25% surcharge for the period from
1953 to September 1956. With costs against petitioner.
The Commissioner, not satisfied with the decision of the Court of Tax
Appeals, appealed to this Court on January 18, 1967, (G.R. No. L-27044).
On the other hand, Engineering, on January 4, 1967, filed with the Court of
Tax Appeals a motion for reconsideration of the decision abovementioned.
This was denied on April 6, 1967, prompting Engineering to file also with
this Court its appeal, docketed as G.R. No. L-27452.
Since the two cases, G.R. No. L-27044 and G.R. No. L-27452, involve the
same parties and issues, We have decided to consolidate and jointly
decide them.
Engineering in its Petition claims that the Court of Tax Appeals committed
the following errors:
1. That the Court of Tax Appeals erred in holding
Engineering Equipment & Supply Company liable to the
30% compensating tax on its importations of equipment
and ordinary articles used in the central type air
conditioning systems it designed, fabricated, constructed
and installed in the buildings and premises of its
customers, rather than to the compensating tax of only
7%;
2. That the Court of Tax Appeals erred in holding
Engineering Equipment & Supply Company guilty of fraud
in effecting the said importations on the basis of
incomplete quotations from the contents of alleged
photostat copies of documents seized illegally from
Engineering Equipment and Supply Company which
should not have been admitted in evidence;

3. That the Court of Tax Appeals erred in holding

Engineering Equipment & Supply Company liable to the
25% surcharge prescribed in Section 190 of the Tax Code;
4. That the Court of Tax Appeals erred in holding the
assessment as not having prescribed;
5. That the Court of Tax Appeals erred in holding
Engineering Equipment & Supply Company liable for the
sum of P174,141.62 as 30% compensating tax and 25%
surcharge instead of completely absolving it from the
deficiency assessment of the Commissioner.
The Commissioner on the other hand claims that the Court of Tax Appeals
erred:
1. In holding that the respondent company is a contractor
and not a manufacturer.
2. In holding respondent company liable to the 3%
contractor's tax imposed by Section 191 of the Tax Code
instead of the 30% sales tax prescribed in Section 185(m)
in relation to Section 194(x) both of the same Code;
3. In holding that the respondent company is subject only
to the 30% compensating tax under Section 190 of the Tax
Code and not to the 30% advance sales tax imposed by
section 183 (b), in relation to section 185(m) both of the
same Code, on its importations of parts and accessories
of air conditioning units;
4. In not holding the company liable to the 50% fraud
surcharge under Section 183 of the Tax Code on its
importations of parts and accessories of air conditioning
units, notwithstanding the finding of said court that the
respondent company fraudulently misdeclared the said
importations;
5. In holding the respondent company liable for
P174,141.62 as compensating tax and 25% surcharge
instead of P740,587.86 as deficiency advance sales tax,
deficiency manufacturers tax and 25% and 50% surcharge
for the period from June 1, 1948 to December 31, 1956.

The main issue revolves on the question of whether or not Engineering is a

manufacturer of air conditioning units under Section 185(m), supra, in
relation to Sections 183(b) and 194 of the Code, or a contractor under
Section 191 of the same Code.
The Commissioner contends that Engineering is a manufacturer and seller
of air conditioning units and parts or accessories thereof and, therefore, it
is subject to the 30% advance sales tax prescribed by Section 185(m) of
the Tax Code, in relation to Section 194 of the same, which defines a
manufacturer as follows:
Section 194. Words and Phrases Defined. In
applying the provisions of this Title, words and phrases
shall be taken in the sense and extension indicated below:
xxx xxx xxx
(x) "Manufacturer" includes every person who by physical
or chemical process alters the exterior texture or form or
inner substance of any raw material or manufactured or
partially manufactured products in such manner as to
prepare it for a special use or uses to which it could not
have been put in its original condition, or who by any such
process alters the quality of any such material or
manufactured or partially manufactured product so as to
reduce it to marketable shape, or prepare it for any of the
uses of industry, or who by any such process combines
any such raw material or manufactured or partially
manufactured products with other materials or products of
the same or of different kinds and in such manner that the
finished product of such process of manufacture can be
put to special use or uses to which such raw material or
manufactured or partially manufactured products in their
original condition could not have been put, and who in
addition alters such raw material or manufactured or
partially manufactured products, or combines the same to
produce such finished products for the purpose of their
sale or distribution to others and not for his own use or
consumption.
In answer to the above contention, Engineering claims that it is not a
manufacturer and setter of air-conditioning units and spare parts or
accessories thereof subject to tax under Section 185(m) of the Tax Code,

but a contractor engaged in the design, supply and installation of the

central type of air-conditioning system subject to the 3% tax imposed by
Section 191 of the same Code, which is essentially a tax on the sale of
services or labor of a contractor rather than on the sale of articles subject
to the tax referred to in Sections 184, 185 and 186 of the Code.
The arguments of both the Engineering and the Commissioner call for a
clarification of the term contractor as well as the distinction between a
contract of sale and contract for furnishing services, labor and materials.
The distinction between a contract of sale and one for work, labor and
materials is tested by the inquiry whether the thing transferred is one not in
existence and which never would have existed but for the order of the
party desiring to acquire it, or a thing which would have existed and has
been the subject of sale to some other persons even if the order had not
been given. 2 If the article ordered by the purchaser is exactly such as the
plaintiff makes and keeps on hand for sale to anyone, and no change or
modification of it is made at defendant's request, it is a contract of sale,
even though it may be entirely made after, and in consequence of, the
defendants order for it. 3
Our New Civil Code, likewise distinguishes a contract of sale from a
contract for a piece of work thus:
Art. 1467. A contract for the delivery at a certain price of
an article which the vendor in the ordinary course of his
business manufactures or procures for the general
market, whether the same is on hand at the time or not, is
a contract of sale, but if the goods are to be manufactured
specially for the customer and upon his special order and
not for the general market, it is a contract for a piece of
work.
The word "contractor" has come to be used with special reference to a
person who, in the pursuit of the independent business, undertakes to do a
specific job or piece of work for other persons, using his own means and
methods without submitting himself to control as to the petty details.
(Araas, Annotations and Jurisprudence on the National Internal Revenue
Code, p. 318, par. 191 (2), 1970 Ed.) The true test of a contractor as was
held in the cases of Luzon Stevedoring Co., vs. Trinidad, 43, Phil. 803,
807-808, andLa Carlota Sugar Central vs. Trinidad, 43, Phil. 816, 819,
would seem to be that he renders service in the course of an independent
occupation, representing the will of his employer only as to the result of his
work, and not as to the means by which it is accomplished.

With the foregoing criteria as guideposts, We shall now examine whether

Engineering really did "manufacture" and sell, as alleged by the
Commissioner to hold it liable to the advance sales tax under Section
185(m), or it only had its services "contracted" for installation purposes to
hold it liable under section 198 of the Tax Code.
I
After going over the three volumes of stenographic notes and the
voluminous record of the BIR and the CTA as well as the exhibits
submitted by both parties, We find that Engineering did not manufacture
air conditioning units for sale to the general public, but imported some
items (as refrigeration compressors in complete set, heat exchangers or
coils, t.s.n. p. 39) which were used in executing contracts entered into by
it. Engineering, therefore, undertook negotiations and execution of
individual contracts for the design, supply and installation of air
conditioning units of the central type (t.s.n. pp. 20-36; Exhs. "F", "G", "H",
"I", "J", "K", "L", and "M"), taking into consideration in the process such
factors as the area of the space to be air conditioned; the number of
persons occupying or would be occupying the premises; the purpose for
which the various air conditioning areas are to be used; and the sources of
heat gain or cooling load on the plant such as sun load, lighting, and other
electrical appliances which are or may be in the plan. (t.s.n. p. 34, Vol. I)
Engineering also testified during the hearing in the Court of Tax Appeals
that relative to the installation of air conditioning system, Engineering
designed and engineered complete each particular plant and that no two
plants were identical but each had to be engineered separately.
As found by the lower court, which finding 4 We adopt
Engineering, in a nutshell, fabricates, assembles, supplies
and installs in the buildings of its various customers the
central type air conditioning system; prepares the plans
and specifications therefor which are distinct and different
from each other; the air conditioning units and spare parts
or accessories thereof used by petitioner are not the
window type of air conditioner which are manufactured,
assembled and produced locally for sale to the general
market; and the imported air conditioning units and spare
parts or accessories thereof are supplied and installed by
petitioner upon previous orders of its customers
conformably with their needs and requirements.

The facts and circumstances aforequoted support the theory that

Engineering is a contractor rather than a manufacturer.
The Commissioner in his Brief argues that "it is more in accord with reason
and sound business management to say that anyone who desires to have
air conditioning units installed in his premises and who is in a position and
willing to pay the price can order the same from the company
(Engineering) and, therefore, Engineering could have mass produced and
stockpiled air conditioning units for sale to the public or to any customer
with enough money to buy the same." This is untenable in the light of the
fact that air conditioning units, packaged, or what we know as selfcontained air conditioning units, are distinct from the central system which
Engineering dealt in. To Our mind, the distinction as explained by
Engineering, in its Brief, quoting from books, is not an idle play of words as
claimed by the Commissioner, but a significant fact which We just cannot
ignore. As quoted by Engineering Equipment & Supply Co., from an
Engineering handbook by L.C. Morrow, and which We reproduce
hereunder for easy reference:
... there is a great variety of equipment in use to do this
job (of air conditioning). Some devices are designed to
serve a specific type of space; others to perform a specific
function; and still others as components to be assembled
into a tailor-made system to fit a particular building.
Generally, however, they may be grouped into two
classifications unitary and central system.
The unitary equipment classification includes those
designs such as room air conditioner, where all of the
functional components are included in one or two
packages, and installation involves only making service
connection such as electricity, water and drains. Centralstation systems, often referred to as applied or built-up
systems, require the installation of components at different
points in a building and their interconnection.
The room air conditioner is a unitary equipment designed
specifically for a room or similar small space. It is unique
among air conditioning equipment in two respects: It is in
the electrical appliance classification, and it is made by a
great number of manufacturers.

There is also the testimony of one Carlos Navarro, a licensed Mechanical

and Electrical Engineer, who was once the Chairman of the Board of
Examiners for Mechanical Engineers and who was allegedly responsible
for the preparation of the refrigeration and air conditioning code of the City
of Manila, who said that "the central type air conditioning system is an
engineering job that requires planning and meticulous layout due to the
fact that usually architects assign definite space and usually the spaces
they assign are very small and of various sizes. Continuing further, he
testified:
I don't think I have seen central type of air conditioning
machinery room that are exactly alike because all our
buildings here are designed by architects dissimilar to
existing buildings, and usually they don't coordinate and
get the advice of air conditioning and refrigerating
engineers so much so that when we come to design, we
have to make use of the available space that they are
assigning to us so that we have to design the different
component parts of the air conditioning system in such a
way that will be accommodated in the space assigned and
afterwards the system may be considered as a definite
portion of the building. ...
Definitely there is quite a big difference in the operation
because the window type air conditioner is a sort of
compromise. In fact it cannot control humidity to the
desired level; rather the manufacturers, by hit and miss,
were able to satisfy themselves that the desired comfort
within a room could be made by a definite setting of the
machine as it comes from the factory; whereas the central
type system definitely requires an intelligent operator.
(t.s.n. pp. 301-305, Vol. II)
The point, therefore, is this Engineering definitely did not and was not
engaged in the manufacture of air conditioning units but had its services
contracted for the installation of a central system. The cases cited by the
Commissioner (Advertising Associates, Inc. vs. Collector of Customs, 97,
Phil. 636; Celestino Co & Co. vs. Collector of Internal Revenue, 99 Phil.
841 and Manila Trading & Supply Co. vs. City of Manila, 56 O.G. 3629),
are not in point. Neither are they applicable because the facts in all the
cases cited are entirely different. Take for instance the case of Celestino
Co where this Court held the taxpayer to be a manufacturer rather than a
contractor of sash, doors and windows manufactured in its factory. Indeed,

from the very start, Celestino Co intended itself to be a manufacturer of

doors, windows, sashes etc. as it did register a special trade name for its
sash business and ordered company stationery carrying the bold print
"ORIENTAL SASH FACTORY (CELESTINO CO AND COMPANY, PROP.)
926 Raon St., Quiapo, Manila, Tel. No. etc., Manufacturers of All Kinds of
Doors, Windows ... ." Likewise, Celestino Co never put up a contractor's
bond as required by Article 1729 of the Civil Code. Also, as a general rule,
sash factories receive orders for doors and windows of special design only
in particular cases, but the bulk of their sales is derived from ready-made
doors and windows of standard sizes for the average home, which "sales"
were reflected in their books of accounts totalling P118,754.69 for the
period from January, 1952 to September 30, 1952, or for a period of only
nine (9) months. This Court found said sum difficult to have been derived
from its few customers who placed special orders for these items. Applying
the abovestated facts to the case at bar, We found them to he inapposite.
Engineering advertised itself as Engineering Equipment and Supply
Company, Machinery Mechanical Supplies, Engineers, Contractors, 174
Marques de Comillas, Manila (Exh. "B" and "15" BIR rec. p. 186), and not
as manufacturers. It likewise paid the contractors tax on all the contracts
for the design and construction of central system as testified to by Mr. Rey
Parker, its President and General Manager. (t.s.n. p. 102, 103) Similarly,
Engineering did not have ready-made air conditioning units for sale but as
per testimony of Mr. Parker upon inquiry of Judge Luciano of the CTA
Q Aside from the general components,
which go into air conditioning plant or
system of the central type which your
company undertakes, and the procedure
followed by you in obtaining and
executing contracts which you have
already testified to in previous hearing,
would you say that the covering contracts
for these different projects listed ...
referred to in the list, Exh. "F" are identical
in every respect? I mean every plan or
system covered by these different
contracts are identical in standard in
every respect, so that you can reproduce
them?
A No, sir. They are not all standard. On
the contrary, none of them are the same.
Each one must be designed and

constructed to meet the particular

requirements, whether the application is
to be operated. (t.s.n. pp. 101-102)
What We consider as on all fours with the case at bar is the case of S.M.
Lawrence Co. vs. McFarland,Commissioner of Internal Revenue of the
State of Tennessee and McCanless, 355 SW 2d, 100, 101, "where the
cause presents the question of whether one engaged in the business of
contracting for the establishment of air conditioning system in buildings,
which work requires, in addition to the furnishing of a cooling unit, the
connection of such unit with electrical and plumbing facilities and the
installation of ducts within and through walls, ceilings and floors to convey
cool air to various parts of the building, is liable for sale or use tax as a
contractor rather than a retailer of tangible personal property. Appellee
took the Position that appellant was not engaged in the business of selling
air conditioning equipment as such but in the furnishing to its customers of
completed air conditioning systems pursuant to contract, was a contractor
engaged in the construction or improvement of real property, and as such
was liable for sales or use tax as the consumer of materials and equipment
used in the consummation of contracts, irrespective of the tax status of its
contractors. To transmit the warm or cool air over the buildings, the
appellant installed system of ducts running from the basic units through
walls, ceilings and floors to registers. The contract called for completed air
conditioning systems which became permanent part of the buildings and
improvements to the realty." The Court held the appellant a contractor
which used the materials and the equipment upon the value of which the
tax herein imposed was levied in the performance of its contracts with its
customers, and that the customers did not purchase the equipment and
have the same installed.
Applying the facts of the aforementioned case to the present case, We see
that the supply of air conditioning units to Engineer's various customers,
whether the said machineries were in hand or not, was especially made for
each customer and installed in his building upon his special order. The air
conditioning units installed in a central type of air conditioning system
would not have existed but for the order of the party desiring to acquire it
and if it existed without the special order of Engineering's customer, the
said air conditioning units were not intended for sale to the general public.
Therefore, We have but to affirm the conclusion of the Court of Tax
Appeals that Engineering is a contractor rather than a manufacturer,
subject to the contractors tax prescribed by Section 191 of the Code and
not to the advance sales tax imposed by Section 185(m) in relation to
Section 194 of the same Code. Since it has been proved to Our

satisfaction that Engineering imported air conditioning units, parts or

accessories thereof for use in its construction business and these items
were never sold, resold, bartered or exchanged, Engineering should be
held liable to pay taxes prescribed under Section 190 5 of the Code. This
compensating tax is not a tax on the importation of goods but a tax on the
use of imported goods not subject to sales tax. Engineering, therefore,
should be held liable to the payment of 30% compensating tax in
accordance with Section 190 of the Tax Code in relation to Section 185(m)
of the same, but without the 50% mark up provided in Section 183(b).
II
We take up next the issue of fraud. The Commissioner charged
Engineering with misdeclaration of the imported air conditioning units and
parts or accessories thereof so as to make them subject to a lower rate of
percentage tax (7%) under Section 186 of the Tax Code, when they are
allegedly subject to a higher rate of tax (30%) under its Section 185(m).
This charge of fraud was denied by Engineering but the Court of Tax
Appeals in its decision found adversely and said"
... We are amply convinced from the evidence presented
by respondent that petitioner deliberately and purposely
misdeclared its importations. This evidence consists of
letters written by petitioner to its foreign suppliers,
instructing them on how to invoice and describe the air
conditioning units ordered by petitioner. ... (p. 218 CTA
rec.)
Despite the above findings, however, the Court of Tax Appeals absolved
Engineering from paying the 50% surcharge prescribe by Section 183(a) of
the Tax Code by reasoning out as follows:
The imposition of the 50% surcharge prescribed by
Section 183(a) of the Tax Code is based on willful neglect
to file the monthly return within 20 days after the end of
each month or in case a false or fraudulent return is
willfully made, it can readily be seen, that petitioner cannot
legally be held subject to the 50% surcharge imposed by
Section 183(a) of the Tax Code. Neither can petitioner be
held subject to the 50% surcharge under Section 190 of
the Tax Code dealing on compensating tax because the
provisions thereof do not include the 50% surcharge.
Where a particular provision of the Tax Code does not

impose the 50% surcharge as fraud penalty we cannot

enforce a non-existing provision of law notwithstanding the
assessment of respondent to the contrary. Instances of
the exclusion in the Tax Code of the 50% surcharge are
those dealing on tax on banks, taxes on receipts of
insurance companies, and franchise tax. However, if the
Tax Code imposes the 50% surcharge as fraud penalty, it
expressly so provides as in the cases of income tax,
estate and inheritance taxes, gift taxes, mining tax,
amusement tax and the monthly percentage taxes.
Accordingly, we hold that petitioner is not subject to the
50% surcharge despite the existence of fraud in the
absence of legal basis to support the importation thereof.
(p. 228 CTA rec.)
We have gone over the exhibits submitted by the Commissioner
evidencing fraud committed by Engineering and We reproduce some of
them hereunder for clarity.
As early as March 18, 1953, Engineering in a letter of even date wrote to
Trane Co. (Exh. "3-K" pp. 152-155, BIR rec.) viz:
Your invoices should be made in the name of Madrigal &
Co., Inc., Manila, Philippines, c/o Engineering Equipment
& Supply Co., Manila, Philippines forwarding all
correspondence and shipping papers concerning this
order to us only and not to the customer.
When invoicing, your invoices should be exactly as
detailed in the customer's Letter Order dated March 14th,
1953 attached. This is in accordance with the Philippine
import licenses granted to Madrigal & Co., Inc. and such
details must only be shown on all papers and shipping
documents for this shipment. No mention of words air
conditioning equipment should be made on any shipping
documents as well as on the cases. Please give this
matter your careful attention, otherwise great difficulties
will be encountered with the Philippine Bureau of Customs
when clearing the shipment on its arrival in Manila. All
invoices and cases should be marked "THIS EQUIPMENT
FOR RIZAL CEMENT CO."

The same instruction was made to Acme Industries, Inc., San Francisco,
California in a letter dated March 19, 1953 (Exh. "3-J-1" pp. 150-151, BIR
rec.)
On April 6, 1953, Engineering wrote to Owens-Corning Fiberglass Corp.,
New York, U.S.A. (Exh. "3-1" pp. 147-149, BIR rec.) also enjoining the
latter from mentioning or referring to the term 'air conditioning' and to
describe the goods on order as Fiberglass pipe and pipe fitting insulation
instead. Likewise on April 30, 1953, Engineering threatened to discontinue
the forwarding service of Universal Transcontinental Corporation when it
wrote Trane Co. (Exh. "3-H" p. 146, BIR rec.):
It will be noted that the Universal Transcontinental
Corporation is not following through on the instructions
which have been covered by the above correspondence,
and which indicates the necessity of discontinuing the use
of the term "Air conditioning Machinery or Air Coolers".
Our instructions concerning this general situation have
been sent to you in ample time to have avoided this error
in terminology, and we will ask that on receipt of this letter
that you again write to Universal Transcontinental Corp.
and inform them that, if in the future, they are unable to
cooperate with us on this requirement, we will thereafter
be unable to utilize their forwarding service. Please inform
them that we will not tolerate another failure to follow our
requirements.
And on July 17, 1953 (Exh- "3-g" p. 145, BIR rec.) Engineering wrote
Trane Co. another letter, viz:
In the past, we have always paid the air conditioning tax
on climate changers and that mark is recognized in the
Philippines, as air conditioning equipment. This matter of
avoiding any tie-in on air conditioning is very important to
us, and we are asking that from hereon that whoever
takes care of the processing of our orders be carefully
instructed so as to avoid again using the term "Climate
changers" or in any way referring to the equipment as "air
conditioning."
And in response to the aforequoted letter, Trane Co. wrote on July 30,
1953, suggesting a solution, viz:

We feel that we can probably solve all the problems by

following the procedure outlined in your letter of March 25,
1953 wherein you stated that in all future jobs you would
enclose photostatic copies of your import license so that
we might make up two sets of invoices: one set describing
equipment ordered simply according to the way that they
are listed on the import license and another according to
our ordinary regular methods of order write-up. We would
then include the set made up according to the import
license in the shipping boxes themselves and use those
items as our actual shipping documents and invoices, and
we will send the other regular invoice to you, by separate
correspondence. (Exh- No. "3-F-1", p. 144 BIR rec.)
Another interesting letter of Engineering is one dated August 27, 1955
(Exh. "3-C" p. 141 BIR rec.)
In the process of clearing the shipment from the piers, one
of the Customs inspectors requested to see the packing
list. Upon presenting the packing list, it was discovered
that the same was prepared on a copy of your letterhead
which indicated that the Trane Co. manufactured air
conditioning, heating and heat transfer equipment.
Accordingly, the inspectors insisted that this equipment
was being imported for air conditioning purposes. To date,
we have not been able to clear the shipment and it is
possible that we will be required to pay heavy taxes on
equipment.
The purpose of this letter is to request that in the future,
no documents of any kind should be sent with the order
that indicate in any way that the equipment could possibly
be used for air conditioning.
It is realized that this a broad request and fairly difficult to
accomplish and administer, but we believe with proper
caution it can be executed. Your cooperation and close
supervision concerning these matters will be appreciated.
(Emphasis supplied)
The aforequoted communications are strongly indicative of the fraudulent
intent of Engineering to misdeclare its importation of air conditioning units
and spare parts or accessories thereof to evade payment of the 30% tax.

And since the commission of fraud is altogether too glaring, We cannot

agree with the Court of Tax Appeals in absolving Engineering from the
50% fraud surcharge, otherwise We will be giving premium to a plainly
intolerable act of tax evasion. As aptly stated by then Solicitor General,
now Justice, Antonio P. Barredo: 'this circumstance will not free it from the
50% surcharge because in any case whether it is subject to advance sales
tax or compensating tax, it is required by law to truly declare its importation
in the import entries and internal revenue declarations before the
importations maybe released from customs custody. The said entries are
the very documents where the nature, quantity and value of the imported
goods declared and where the customs duties, internal revenue taxes, and
other fees or charges incident to the importation are computed. These
entries, therefore, serve the same purpose as the returns required by
Section 183(a) of the Code.'
Anent the 25% delinquency surcharge, We fully agree to the ruling made
by the Court of Tax Appeals and hold Engineering liable for the same. As
held by the lower court:
At first blush it would seem that the contention of petitioner
that it is not subject to the delinquency, surcharge of 25%
is sound, valid and tenable. However, a serious study and
critical analysis of the historical provisions of Section 190
of the Tax Code dealing on compensating tax in relation to
Section 183(a) of the same Code, will show that the
contention of petitioner is without merit. The original text of
Section 190 of Commonwealth Act 466, otherwise known
as the National Internal Revenue Code, as amended by
Commonwealth Act No. 503, effective on October 1, 1939,
does not provide for the filing of a compensation tax return
and payment of the 25 % surcharge for late payment
thereof. Under the original text of Section 190 of the Tax
Code as amended by Commonwealth Act No. 503, the
contention of the petitioner that it is not subject to the 25%
surcharge appears to be legally tenable. However, Section
190 of the Tax Code was subsequently amended by the
Republic Acts Nos. 253, 361, 1511 and 1612 effective
October 1, 1946, July 1, 1948, June 9, 1949, June 16,
1956 and August 24, 1956 respectively, which invariably
provides among others, the following:
... If any article withdrawn from the
customhouse or the post office without

payment of the compensating tax is

subsequently used by the importer for
other purposes, corresponding entry
should be made in the books of accounts
if any are kept or a written notice thereof
sent to the Collector of Internal Revenue
and payment of the corresponding
compensating tax made within 30 days
from the date of such entry or notice and
if tax is not paid within such period the
amount of the tax shall be increased by
25% the increment to be a part of the tax.
Since the imported air conditioning units-and spare parts or accessories
thereof are subject to the compensating tax of 30% as the same were
used in the construction business of Engineering, it is incumbent upon the
latter to comply with the aforequoted requirement of Section 190 of the
Code, by posting in its books of accounts or notifying the Collector of
Internal Revenue that the imported articles were used for other purposes
within 30 days. ... Consequently; as the 30% compensating tax was not
paid by petitioner within the time prescribed by Section 190 of the Tax
Code as amended, it is therefore subject to the 25% surcharge for
delinquency in the payment of the said tax. (pp. 224-226 CTA rec.)

within ten years after the discovery of the falsity, fraud or

omission.
is applicable, considering the preponderance of evidence of fraud with the
intent to evade the higher rate of percentage tax due from Engineering.
The, tax assessment was made within the period prescribed by law and
prescription had not set in against the Government.
WHEREFORE, the decision appealed from is affirmed with the
modification that Engineering is hereby also made liable to pay the 50%
fraud surcharge.
SO ORDERED.

THIRD DIVISION
[G.R. No. 52267. January 24, 1996]

III
Lastly the question of prescription of the tax assessment has been put in
issue. Engineering contends that it was not guilty of tax fraud in effecting
the importations and, therefore, Section 332(a) prescribing ten years is
inapplicable, claiming that the pertinent prescriptive period is five years
from the date the questioned importations were made. A review of the
record however reveals that Engineering did file a tax return or declaration
with the Bureau of Customs before it paid the advance sales tax of 7%.
And the declaration filed reveals that it did in fact misdeclare its
importations. Section 332 of the Tax Code which provides:
Section 332. Exceptions as to period of limitation of
assessment and collection of taxes.
(a) In the case of a false or fraudulent return with intent to
evade tax or of a failure to file a return, the tax may be
assessed, or a proceeding in court for the collection of
such tax may be begun without assessment at any time

ENGINEERING & MACHINERY CORPORATION, petitioner, vs. COURT

OF APPEALS and PONCIANO L. ALMEDA, respondents.
DECISION
PANGANIBAN, J.:
Is a contract for the fabrication and installation of a central airconditioning system in a building, one of sale or for a piece of work? What
is the prescriptive period for filing actions for breach of the terms of such
contract?
These are the legal questions brought before this Court in this Petition
for review on certiorari under Rule 45 of the Rules of Court, to set aside
the Decision[1] of the Court of Appeals[2]in CA-G.R. No. 58276-R
promulgated on November 28, 1978 (affirming in toto the decision[3] dated
April 15, 1974 of the then Court of First Instance of Rizal, Branch II, [4] in
Civil Case No. 14712, which ordered petitioner to pay private respondent

the amount needed to rectify the faults and deficiencies of the airconditioning system installed by petitioner in private respondents building,
plus damages, attorneys fees and costs).
By a resolution of the First Division of this Court dated November 13,
1995, this case was transferred to the Third. After deliberating on the
various submissions of the parties, including the petition, record on appeal,
private respondents comment and briefs for the petitioner and the private
respondent, the Court assigned the writing of this Decision to the
undersigned, who took his oath as a member of the Court on October 10,
1995.
The Facts
Pursuant to the contract dated September 10, 1962 between
petitioner and private respondent, the former undertook to fabricate,
furnish and install the air-conditioning system in the latters building
along Buendia Avenue, Makati in consideration of P210,000.00. Petitioner
was to furnish the materials, labor, tools and all services required in order
to so fabricate and install said system. The system was completed in 1963
and accepted by private respondent, who paid in full the contract price.
On September 2, 1965, private respondent sold the building to the
National Investment and Development Corporation (NIDC). The latter took
possession of the building but on account of NIDCs noncompliance with
the terms and conditions of the deed of sale, private respondent was able
to secure judicial rescission thereof. The ownership of the building having
been decreed back to private respondent, he re-acquired possession
sometime in 1971. It was then that he learned from some NIDC employees
of the defects of the air-conditioning system of the building.
Acting on this information, private respondent commissioned
Engineer David R. Sapico to render a technical evaluation of the system in
relation to the contract with petitioner. In his report, Sapico enumerated the
defects of the system and concluded that it was not capable of maintaining
the desired room temperature of 76F - 2F (Exhibit C)[5]
On the basis of this report, private respondent filed on May 8, 1971 an
action for damages against petitioner with the then Court of First Instance
of Rizal (Civil Case No. 14712). The complaint alleged that the airconditioning system installed by petitioner did not comply with the agreed
plans and specifications. Hence, private respondent prayed for the amount

of P2 10,000.00 representing the rectification cost, P100,000.00 as

damages and P15,000.00 as attorneys fees.
Petitioner moved to dismiss the complaint, alleging that the
prescriptive period of six months had set in pursuant to Articles 1566 and
1567, in relation to Article 1571 of the Civil Code, regarding the
responsibility of a vendor for any hidden faults or defects in the thing sold.
Private respondent countered that the contract dated September 10,
1962 was not a contract of sale but a contract for a piece of work under
Article 1713 of the Civil Code. Thus, in accordance with Article 1144 (1) of
the same Code, the complaint was timely brought within the ten-year
prescriptive period.
In its reply, petitioner argued that Article 1571 of the Civil Code
providing for a six-month prescriptive period is applicable to a contract for
a piece of work by virtue of Article 1714, which provides that such a
contract shall be governed by the pertinent provisions on warranty of title
and against hidden defects and the payment of price in a contract of sale. [6]
The trial court denied the motion to dismiss. In its answer to the
complaint, petitioner reiterated its claim of prescription as an affirmative
defense. It alleged that whatever defects might have been discovered in
the air-conditioning system could have been caused by a variety of factors,
including ordinary wear and tear and lack of proper and regular
maintenance. It pointed out that during the one-year period that private
respondent withheld final payment, the system was subjected to very rigid
inspection and testing and corrections or modifications effected by
petitioner. It interposed a compulsory counterclaim suggesting that the
complaint was filed to offset the adverse effects of the judgment in Civil
Case No. 71494, Court of First Instance of Manila, involving the same
parties, wherein private respondent was adjudged to pay petitioner the
balance of the unpaid contract price for the air-conditioning system
installed in another building of private respondent, amounting to
P138,482.25.
Thereafter, private respondent filed an ex-parte motion for preliminary
attachment on the strength of petitioners own statement to the effect that it
had sold its business and was no longer doing business in Manila. The
trial court granted the motion and, upon private respondents posting of a
bond of P50,000.00, ordered the issuance of a writ of attachment.

In due course, the trial court rendered a decision finding that

petitioner failed to install certain parts and accessories called for by the
contract, and deviated from the plans of the system, thus reducing its
operational effectiveness to the extent that 35 window-type units had to be
installed in the building to achieve a fairly desirable room temperature. On
the question of prescription, the trial court ruled that the complaint was
filed within the ten-year prescriptive period although the contract was one
for a piece of work, because it involved the installation of an airconditioning system which the defendant itself manufactured, fabricated,
designed and installed.
Petitioner appealed to the Court of Appeals, which affirmed the
decision of the trial court. Hence, it instituted the instant petition.
The Submissions of the Parties
In the instant Petition, petitioner raised three issues. First, it
contended that private respondents acceptance of the work and his
payment of the contract price extinguished any liability with respect to the
defects in the air-conditioning system. Second, it claimed that the Court of
Appeals erred when it held that the defects in the installation were not
apparent at the time of delivery and acceptance of the work considering
that private respondent was not an expert who could recognize such
defects. Third, it insisted that, assuming arguendo that there were indeed
hidden defects, private respondents complaint was barred by prescription
under Article 1571 of the Civil Code, which provides for a six-month
prescriptive period.
Private respondent, on the other hand, averred that the issues raised
by petitioner, like the question of whether there was an acceptance of the
work by the owner and whether the hidden defects in the installation could
have been discovered by simple inspection, involve questions of fact which
have been passed upon by the appellate court.
The Courts Ruling
The Supreme Court reviews only errors of law in petitions for review
on certiorari under Rule 45. It is not the function of this Court to re-examine
the findings of fact of the appellate court unless said findings are not
supported by the evidence on record or the judgment is based on a
misapprehension of facts.[7]

The Court has consistently held that the factual findings of the trial court, as well
as the Court of Appeals, are final and conclusive and may not be reviewed on
appeal. Among the exceptional circumstances where a reassessment of facts found
by the lower courts is allowed are when the conclusion is a finding grounded
entirely on speculation, surmises or conjectures; when the inference made is
manifestly absurd, mistaken or impossible; when there is grave abuse of discretion
in the appreciation of facts; when the judgment is premised on a misapprehension
of facts; when the findings went beyond the issues of the case and the same are
contrary to the admissions of both appellant and appellee. After a careful study of
the case at bench, we find none of the above grounds present to justify the reevaluation of the findings of fact made by the courts below.[8]
We see no valid reason to discard the factual conclusions of the appellate court. x
x x (I)t is not the function of this Court to assess and evaluate all over again the
evidence, testimonial and documentary, adduced by the parties, particularly
where, such as here, the findings of both the trial court and the appellate court on
the matter coincide.[9] (Italics supplied)
Hence, the first two issues will not be resolved as they raise questions of
fact.
Thus, the only question left to be resolved is that of prescription. In
their submissions, the parties argued lengthily on the nature of the contract
entered into by them, viz., whether it was one of sale or for a piece of
work.
Article 1713 of the Civil Code defines a contract for a piece of work
thus:
By the contract for a piece of work the contractor binds himself to execute a piece
of work for the employer, in consideration of a certain price or compensation. The
contractor may either employ only his labor or skill, or also furnish the material.
A contract for a piece of work, labor and materials may be
distinguished from a contract of sale by the inquiry as to whether the thing
transferred is one not in existence and which would never have existed but
for the order of the person desiring it. [10] In such case, the contract is one
for a piece of work, not a sale. On the other hand, if the thing subject of the
contract would have existed and been the subject of a sale to some other
person even if the order had not been given, then the contract is one of
sale.[11]
Thus, Mr. Justice Vitug[12] explains that

A contract for the delivery at a certain price of an article which the vendor in the
ordinary course of his business manufactures or procures for the general market,
whether the same is on hand at the time or not is a contract of sale, but if the
goods are to be manufactured specially for the customer and upon his special
order, and not for the general market, it is a contract for a piece of work (Art.
1467, Civil Code).The mere fact alone that certain articles are made upon previous
orders of customers will not argue against the imposition of the sales tax if such
articles are ordinarily manufactured by the taxpayer for sale to the
public (Celestino Co vs. Collector, 99 Phil. 841).
To Tolentino, the distinction between the two contracts depends on
the intention of the parties. Thus, if the parties intended that at some future
date an object has to be delivered, without considering the work or labor of
the party bound to deliver, the contract is one of sale. But if one of the
parties accepts the undertaking on the basis of some plan, taking into
account the work he will employ personally or through another, there is a
contract for a piece of work.[13]
Clearly, the contract in question is one for a piece of work. It is not
petitioners line of business to manufacture air-conditioning systems to be
sold off-the-shelf. Its business and particular field of expertise is the
fabrication and installation of such systems as ordered by customers and
in accordance with the particular plans and specifications provided by the
customers.Naturally, the price or compensation for the system
manufactured and installed will depend greatly on the particular plans and
specifications agreed upon with the customers.
The obligations of a contractor for a piece of work are set forth in
Articles 1714 and 1715 of the Civil Code, which provide:
Art. 1714. If the contractor agrees to produce the work from material furnished by
him, he shall deliver the thing produced to the employer and transfer dominion
over the thing. This contract shall be governed by the following articles as well as
by the pertinent provisions on warranty of title and against hidden defects and the
payment of price in a contract of sale.
Art. 1715. The contractor shall execute the work in such a manner that it has the
qualities agreed upon and has no defects which destroy or lessen its value or
fitness for its ordinary or stipulated use. Should the work be not of such quality,
the employer may require that the contractor remove the defect or execute another
work. If the contractor fails or refuses to comply with this obligation, the
employer may have the defect removed or another work executed, at the
contractors cost.

The provisions on warranty against hidden defects, referred to in Art.

1714 above-quoted, are found in Articles 1561 and 1566, which read as
follows:
Art. 1561. The vendor shall be responsible for warranty against the hidden defects
which the thing sold may have, should they render it unfit for the use for which it
is intended, or should they diminish its fitness for such use to such an extent that,
had the vendee been aware thereof, he would not have acquired it or would have
given a lower price for it; but said vendor shall not be answerable for patent
defects or those which may be visible, or for those which are not visible if the
vendee is an expert who, by reason of his trade or profession, should have known
them.
xxx xxx xxx
Art. 1566. The vendor is responsible to the vendee for any hidden faults or defects
in the thing sold, even though he was not aware thereof.
This provision shall not apply if the contrary has been stipulated, and the vendor
was not aware of the hidden faults or defects in the thing sold.
The remedy against violations of the warranty against hidden defects
is either to withdraw from the contract (redhibitory action) or to demand
a proportionate reduction of the price(accion quanti minoris), with
damages in either case.[14]
In Villostas vs. Court of Appeals,[15] we held that, while it is true that
Article 1571 of the Civil Code provides for a prescriptive period of six
months for a redhibitory action, a cursory reading of the ten preceding
articles to which it refers will reveal that said rule may be applied only in
case of implied warranties; and where there is an express warranty in the
contract, as in the case at bench, the prescriptive period is the one
specified in the express warranty, and in the absence of such period, the
general rule on rescission of contract, which is four years (Article 1389,
Civil Code) shall apply.[16]
Consistent with the above discussion, it would appear that this suit is
barred by prescription because the complaint was filed more than four
years after the execution of the contract and the completion of the airconditioning system.
However, a close scrutiny of the complaint filed in the trial court
reveals that the original action is not really for enforcement of the

warranties against hidden defects, but one for breach of the contract
itself. It alleged[17] that the petitioner, in the installation of the airconditioning system did not comply with the specifications provided in the
written agreement between the parties, and an evaluation of the airconditioning system as installed by the defendant showed the following
defects and violations of the specifications of the agreement, to wit:

5. Suitable heat exchanger is not installed. This is an

important component to increase refrigeration
efficiency.
6. Modulating thermostat not provided.

GROUND FLOOR:

7. Water treatment device for evaporative condenser was

not provided.

A. RIGHT WING:

8. Liquid receiver not provided by sight glass.

Equipped with Worthington Compressor, Model 2VC4 directly driven

by an Hp Elm electric motor 1750 rmp, 3 phase, 60 cycles, 220 volts,
complete with starter evaporative condenser, circulating water pump,
air handling unit air ducts.

B. LEFT WING:

Defects Noted:

Defects Noted:

1. Deteriorated evaporative condenser panels, coils are full

of scales and heavy corrosion is very evident.
2. Defective gauges of compressors;
3. No belt guard on motor;
4. Main switch has no cover;
5. Desired room temperature not attained;
Aside from the above defects, the following were noted not installed
although provided in the specifications.
1. Face and by-pass damper of G.I. sheets No. 16. This
damper regulates the flow of cooled air depending on
room condition.

Worthington Compressor Model 2VC4 is installed complete with 15

Hp electric motOr, 3 phase, 220 volts 60 cycles with starter.

Same as right wing. except No. 4. All other defects on right wing are
common to the left wing.
SECOND FLOOR: (Common up to EIGHT FLOORS)
Compressors installed are MELCO with 7.5 Hp V-belt driven by 1800
RPM, 220 volts, 60 cycles, 3 phase, Thrige electric motor with
starters.
As stated in the specifications under Section No. IV, the MELCO
compressors do not satisfy the conditions stated therein due to the
following:
1. MELCO Compressors are not provided with automatic
capacity unloader.
2. Not provided with oil pressure safety control.

2. No fresh air intake provision were provided which is very

necessary for efficient comfort cooling.

3. Particular compressors do not have provision for renewal

sleeves.

3. No motor to regulate the face and by-pass damper.

Out of the total 15 MELCO compressors installed to serve the 2nd

floor up to 8th floors, only six (6) units are in operation and the rest

4. Liquid level indicator for refrigerant not provided.

were already replaced. Of the remaining six (6) units, several of them
have been replaced with bigger cranks hafts.

defendant liable to the plaintiff in the amount necessary to rectify to put the air
conditioning system in its proper operational condition to make it serve the
purpose for which the plaintiff entered into the contract with the defendant.

NINTH FLOOR:
Two (2) Worthington 2VC4 driven by 15 Hp, 3 phase, 220 volts, 60
cycles, 1750 rpm, Higgs motors with starters.
Defects Noted are similar to ground floor.
GENERAL REMARKS:
Under Section III, Design conditions of specification for air
conditioning work, and taking into account A & B same, the present
systems are not capable of maintaining the desired room temperature
of 76 = 2F (sic).
The present tenant have installed 35 window type air conditioning
units distributed among the different floor levels. Temperature
measurements conducted on March 29, 1971, revealed that 78F room
(sic) is only maintained due to the additional window type units.
The trial court, after evaluating the evidence presented, held that,
indeed, petitioner failed to install items and parts required in the contract
and substituted some other items which were not in accordance with the
specifications,[18] thus:
From all of the foregoing, the Court is persuaded to believe the plaintiff that not
only had the defendant failed to install items and parts provided for in the
specifications of the air-conditioning system be installed, like face and by-pass
dampers and modulating thermostat and many others, but also that there are items,
parts and accessories which were used and installed on the air-conditioning system
which were not in full accord with contract specifications. These omissions to
install the equipments, parts and accessories called for in the specifications of the
contract, as well as the deviations made in putting into the air-conditioning system
equipments, parts and accessories not in full accord with the contract specification
naturally resulted to adversely affect the operational effectiveness of the airconditioning system which necessitated the installation of thirty-five window type
of air-conditioning units distributed among the different floor levels in order to be
able to obtain a fairly desirable room temperature for the tenants and actual
occupants of the building. The Court opines and so holds that the failure of the
defendant to follow the contract specifications and said omissions and deviations
having resulted in the operational ineffectiveness of the system installed makes the

The respondent Court affirmed the trial courts decision thereby

making the latters findings also its own.
Having concluded that the original complaint is one for damages
arising from breach of a written contract - and not a suit to enforce
warranties against hidden defects - we herewith declare that the governing
law is Article 1715 (supra). However, inasmuch as this provision does not
contain a specific prescriptive period, the general law on prescription,
which is Article 1144 of the Civil Code, will apply. Said provision
states, inter alia, that actions upon a written contract prescribe in ten (10)
years. Since the governing contract was executed on September 10,
1962 and the complaint was filed on May 8, 1971, it is clear that the action
has not prescribed.
What about petitioners contention that acceptance of the work by the
employer relieves the contractor of liability for any defect in the work? This
was answered by respondent Court [19]as follows:
As the breach of contract which gave rise to the instant case consisted in
appellants omission to install the equipments (sic), parts and accessories not in
accordance with the plan and specifications provided for in the contract and the
deviations made in putting into the air conditioning system parts and accessories
not in accordance with the contract specifications, it is evident that the defect in
the installation was not apparent at the time of the delivery and acceptance of the
work, considering further that plaintiff is not an expert to recognize the same.
From the very nature of things, it is impossible to determine by the simple
inspection of air conditioning system installed in an 8-floor building whether it
has been furnished and installed as per agreed specifications.
Verily, the mere fact that the private respondent accepted the work
does not, ipso facto, relieve the petitioner from liability for deviations from
and violations of the written contract, as the law gives him ten (10) years
within which to file an action based on breach thereof.
WHEREFORE, the petition is hereby DENIED and the assailed
Decision is AFFIRMED. No costs.
SO ORDERED.