G.R. No.

L-12287            August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,

vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy
Collector of Internal Revenue, defendants-appellees.

Gregorio Araneta for appellants.

Assistant Attorney Round for appellees.

MALCOLM, J.:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference
to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The marriage
was contracted under the provisions of law concerning conjugal partnerships (sociedad de
gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on the prescribed form
with the Collector of Internal Revenue, showing, as his total net income for the year 1914, the sum of
P296,302.73. Subsequently Madrigal submitted the claim that the said P296,302.73 did not
represent his income for the year 1914, but was in fact the income of the conjugal partnership
existing between himself and his wife Susana Paterno, and that in computing and assessing the
additional income tax provided by the Act of Congress of October 3, 1913, the income declared by
Vicente Madrigal should be divided into two equal parts, one-half to be considered the income of
Vicente Madrigal and the other half of Susana Paterno. The general question had in the meantime
been submitted to the Attorney-General of the Philippine Islands who in an opinion dated March 17,
1915, held with the petitioner Madrigal. The revenue officers being still unsatisfied, the
correspondence together with this opinion was forwarded to Washington for a decision by the United
States Treasury Department. The United States Commissioner of Internal Revenue reversed the
opinion of the Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely by the
Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife Susana Paterno in
the Court of First Instance of the city of Manila against Collector of Internal Revenue and the Deputy
Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged to have been
wrongfully and illegally collected by the defendants from the plaintiff, Vicente Madrigal, under the
provisions of the Act of Congress known as the Income Tax Law. The burden of the complaint was
that if the income tax for the year 1914 had been correctly and lawfully computed there would have
been due payable by each of the plaintiffs the sum of P2,921.09, which taken together amounts of a
total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the plaintiff
Vicente Madrigal, with the result that plaintiff Madrigal has paid as income tax for the year 1914,
P3,786.08, in excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and
the stipulation, sets forth the basis of defendants' stand in the following way: The income of Vicente
Madrigal and his wife Susana Paterno of the year 1914 was made up of three items: (1)
P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2) P4,086.50,
the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the profits made by
Vicente Madrigal in a pawnshop company. The sum of these three items is P383,181.97, the gross
income of Vicente Madrigal and Susana Paterno for the year 1914. General deductions were
claimed and allowed in the sum of P86,879.24. The resulting net income was P296,302.73. For the
purpose of assessing the normal tax of one per cent on the net income there were allowed as
specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at source, and
(2) P8,000, the specific exemption granted to Vicente Madrigal and Susana Paterno, husband and
wife. The remainder, P271,614.93 was the sum upon which the normal tax of one per cent was
assessed. The normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in
the Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without
costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income tax, is that
is should be divided into two equal parts, because of the conjugal partnership existing between
them. The learned argument of counsel is mostly based upon the provisions of the Civil Code
establishing the sociedad de gananciales. The counter contentions of appellees are that the taxes
imposed by the Income Tax Law are as the name implies taxes upon income tax and not upon
capital and property; that the fact that Madrigal was a married man, and his marriage contracted
under the provisions governing the conjugal partnership, has no bearing on income considered as
income, and that the distinction must be drawn between the ordinary form of commercial partnership
and the conjugal partnership of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been given the
course of history. The final stage has been the selection of income as the norm of taxation.
(See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States,
extended to the Philippine Islands, is the result of an effect on the part of the legislators to put into
statutory form this canon of taxation and of social reform. The aim has been to mitigate the evils
arising from inequalities of wealth by a progressive scheme of taxation, which places the burden on
those best able to pay. To carry out this idea, public considerations have demanded an exemption
roughly equivalent to the minimum of subsistence. With these exceptions, the income tax is
supposed to reach the earnings of the entire non-governmental property of the country. Such is the
background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference between
capital and income is that capital is a fund; income is a flow. A fund of property existing at an instant
of time is called capital. A flow of services rendered by that capital by the payment of money from it
or any other benefit rendered by a fund of capital in relation to such fund through a period of time is
called an income. Capital is wealth, while income is the service of wealth. (See Fisher, "The Nature
of Capital and Income.") The Supreme Court of Georgia expresses the thought in the following
figurative language: "The fact is that property is a tree, income is the fruit; labor is a tree, income the
fruit; capital is a tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on
income is not a tax on property. "Income," as here used, can be defined as "profits or gains."
(London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N.
S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition
[1915], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon
[1890], 136 U.S., 549; and Towne vs. Eisner, decided by the United States Supreme Court, January
7, 1918.)
A regulation of the United States Treasury Department relative to returns by the husband and wife
not living apart, contains the following:

The husband, as the head and legal representative of the household and general custodian of its
income, should make and render the return of the aggregate income of himself and wife, and for the
purpose of levying the income tax it is assumed that he can ascertain the total amount of said
income. If a wife has a separate estate managed by herself as her own separate property, and
receives an income of more than $3,000, she may make return of her own income, and if the
husband has other net income, making the aggregate of both incomes more than $4,000, the wife's
return should be attached to the return of her husband, or his income should be included in her
return, in order that a deduction of $4,000 may be made from the aggregate of both incomes. The
tax in such case, however, will be imposed only upon so much of the aggregate income of both shall
exceed $4,000. If either husband or wife separately has an income equal to or in excess of $3,000, a
return of annual net income is required under the law, and such return must include the income of
both, and in such case the return must be made even though the combined income of both be less
than $4,000. If the aggregate net income of both exceeds $4,000, an annual return of their combined
incomes must be made in the manner stated, although neither one separately has an income of
$3,000 per annum. They are jointly and separately liable for such return and for the payment of the
tax. The single or married status of the person claiming the specific exemption shall be determined
as one of the time of claiming such exemption which return is made, otherwise the status at the
close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine Islands, we
turn for a moment to consider the provisions of the Civil Code dealing with the conjugal partnership.
Recently in two elaborate decisions in which a long line of Spanish authorities were cited, this court
in speaking of the conjugal partnership, decided that "prior to the liquidation the interest of the wife
and in case of her death, of her heirs, is an interest inchoate, a mere expectancy, which constitutes
neither a legal nor an equitable estate, and does not ripen into title until there appears that there are
assets in the community as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose
[1916], 15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband
Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate
property rights and in the ultimate ownership of property acquired as income after such income has
become capital. Susana Paterno has no absolute right to one-half the income of the conjugal
partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return
in order to receive the benefit of the exemption which would arise by reason of the additional tax. As
she has no estate and income, actually and legally vested in her and entirely distinct from her
husband's property, the income cannot properly be considered the separate income of the wife for
the purposes of the additional tax. Moreover, the Income Tax Law does not look on the spouses as
individual partners in an ordinary partnership. The husband and wife are only entitled to the
exemption of P8,000 specifically granted by the law. The higher schedules of the additional tax
directed at the incomes of the wealthy may not be partially defeated by reliance on provisions in our
Civil Code dealing with the conjugal partnership and having no application to the Income Tax Law.
The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter overruling
the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.
Income Tax.

FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission of
income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau, advises that
the Insular Auditor has been authorized to suspend action on the warrants in question until
an authoritative decision on the points raised can be secured from the Treasury
Department."

From the correspondence it appears that Gregorio Araneta, married and living with his wife,
had an income of an amount sufficient to require the imposition of the net income was
properly computed and then both income and deductions and the specific exemption were
divided in half and two returns made, one return for each half in the names respectively of
the husband and wife, so that under the returns as filed there would be an escape from the
additional tax; that Araneta claims the returns are correct on the ground under the Philippine
law his wife is entitled to half of his earnings; that Araneta has dominion over the income and
under the Philippine law, the right to determine its use and disposition; that in this case the
wife has no "separate estate" within the contemplation of the Act of October 3, 1913, levying
an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax was
assessed against the entire net income against Gregorio Araneta; that the tax was paid and
an application for refund made, and that the application for refund was rejected, whereupon
the matter was submitted to the Attorney-General of the Islands who holds that the returns
were correctly rendered, and that the refund should be allowed; and thereupon the question
at issue is submitted through the Governor-General of the Islands and Bureau of Insular
Affairs for the advisory opinion of this office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be
administered as in the United States but by the appropriate internal-revenue officers of the
Philippine Government. You are therefore advised that upon the facts as stated, this office
holds that for the Federal Income Tax (Act of October 3, 1913), the entire net income in this
case was taxable to Gregorio Araneta, both for the normal and additional tax, and that the
application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax Law is
that which belongs to her solely and separate and apart from her husband, and over which
her husband has no right in equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that each
person of lawful age (not excused from so doing) having a net income of $3,000 or over for
the taxable year shall make a return showing the facts; that from the net income so shown
there shall be deducted $3,000 where the person making the return is a single person, or
married and not living with consort, and $1,000 additional where the person making the
return is married and living with consort; but that where the husband and wife both make
 returns (they living together), the amount of deduction from the aggregate of their several
incomes shall not exceed $4,000.

The only occasion for a wife making a return is where she has income from a sole and
separate estate in excess of $3,000, but together they have an income in excess of $4,000,
in which the latter event either the husband or wife may make the return but not both. In all
instances the income of husband and wife whether from separate estates or not, is taken as
a whole for the purpose of the normal tax. Where the wife has income from a separate estate
makes return made by her husband, while the incomes are added together for the purpose
of the normal tax they are taken separately for the purpose of the additional tax. In this case,
however, the wife has no separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.
Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax
Law was drafted by the Congress of the United States and has been by the Congress extended to
the Philippine Islands. Being thus a law of American origin and being peculiarly intricate in its
provisions, the authoritative decision of the official who is charged with enforcing it has peculiar force
for the Philippines. It has come to be a well-settled rule that great weight should be given to the
construction placed upon a revenue law, whose meaning is doubtful, by the department charged
with its execution. (U.S. vs. Cerecedo Hermanos y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2
Phil., 630; Government of the Philippine Islands vs. Municipality of Binalonan, and Roman Catholic
Bishop of Nueva Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is
hereby affirmed with costs against appellants. So ordered.

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

G.R. No. 78953             July 31, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.

Elison G. Natividad for accused-appellant.

SARMIENTO, J.:
Central in this controversy is the issue as to whether or not a taxpayer who merely states as a
footnote in his income tax return that a sum of money that he erroneously received and already
spent is the subject of a pending litigation and there did not declare it as income is liable to pay the
50% penalty for filing a fraudulent return.

This question is the subject of the petition for review before the Court of the portion of the
Decision  dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393, entitled,
1

"Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as Commissioner of Internal Revenue,"
which orders the deletion of the 50% surcharge from Javier's deficiency income tax assessment on
his income for 1977.

The respondent CTA in a Resolution  dated May 25, 1987, denied the Commissioner's Motion for
2

Reconsideration  and Motion for New Trial  on the deletion of the 50% surcharge assessment or
3 4

imposition.

The pertinent facts as are accurately stated in the petition of private respondent Javier in the CTA
and incorporated in the assailed decision now under review, read as follows:

x x x           x x x          x x x

2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner (private
respondent herein), received from the Prudential Bank and Trust Company in Pasay City the
amount of US$999,973.70 remitted by her sister, Mrs. Dolores Ventosa, through some banks
in the United States, among which is Mellon Bank, N.A.

3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the Court of First
Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No. 26899), against the
petitioner (private respondent herein), his wife and other defendants, claiming that its
remittance of US$1,000,000.00 was a clerical error and should have been US$1,000.00
only, and praying that the excess amount of US$999,000.00 be returned on the ground that
the defendants are trustees of an implied trust for the benefit of Mellon Bank with the clear,
immediate, and continuing duty to return the said amount from the moment it was received.

4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an Information with
the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.) charging the petitioner
(private respondent herein) and his wife with the crime of estafa, alleging that they
misappropriated, misapplied, and converted to their own personal use and benefit the
amount of US$999,000.00 which they received under an implied trust for the benefit of
Mellon Bank and as a result of the mistake in the remittance by the latter.

5. That on March 15, 1978, the petitioner (private respondent herein) filed his Income Tax
Return for the taxable year 1977 showing a gross income of P53,053.38 and a net income of
P48,053.88 and stating in the footnote of the return that "Taxpayer was recipient of some
money received from abroad which he presumed to be a gift but turned out to be an error
and is now subject of litigation."

6. That on or before December 15, 1980, the petitioner (private respondent herein) received
a letter from the acting Commissioner of Internal Revenue dated November 14, 1980,
together with income assessment notices for the years 1976 and 1977, demanding that
petitioner (private respondent herein) pay on or before December 15, 1980 the amount of
P1,615.96 and P9,287,297.51 as deficiency assessments for the years 1976 and 1977
respectively. . . .
 7. That on December 15, 1980, the petitioner (private respondent herein) wrote the Bureau
of Internal Revenue that he was paying the deficiency income assessment for the year 1976
but denying that he had any undeclared income for the year 1977 and requested that the
assessment for 1977 be made to await final court decision on the case filed against him for
filing an allegedly fraudulent return. . . .

8. That on November 11, 1981, the petitioner (private respondent herein) received from
Acting Commissioner of Internal Revenue Romulo Villa a letter dated October 8, 1981 stating
in reply to his December 15, 1980 letter-protest that "the amount of Mellon Bank's erroneous
remittance which you were able to dispose, is definitely taxable." . . .
5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal  before the respondent Court of Tax Appeals on December 10,
6

1981.

The respondent CTA, after the proper proceedings, rendered the challenged decision. We quote the
concluding portion:

We note that in the deficiency income tax assessment under consideration, respondent
(petitioner here) further requested petitioner (private respondent here) to pay 50% surcharge
as provided for in Section 72 of the Tax Code, in addition to the deficiency income tax of
P4,888,615.00 and interest due thereon. Since petitioner (private respondent) filed his
income tax return for taxable year 1977, the 50% surcharge was imposed, in all probability,
by respondent (petitioner) because he considered the return filed false or fraudulent. This
additional requirement, to our mind, is much less called for because petitioner (private
respondent), as stated earlier, reflected in as 1977 return as footnote that "Taxpayer was
recipient of some money received from abroad which he presumed to be gift but turned out
to be an error and is now subject of litigation."

From this, it can hardly be said that there was actual and intentional fraud, consisting of
deception willfully and deliberately done or resorted to by petitioner (private respondent) in
order to induce the Government to give up some legal right, or the latter, due to a false
return, was placed at a disadvantage so as to prevent its lawful agents from proper
assessment of tax liabilities. (Aznar vs. Court of Tax Appeals, L-20569, August 23, 1974, 56
(sic) SCRA 519), because petitioner literally "laid his cards on the table" for respondent to
examine. Error or mistake of fact or law is not fraud. (Insular Lumber vs. Collector, L-7100,
April 28, 1956.). Besides, Section 29 is not too plain and simple to understand. Since the
question involved in this case is of first impression in this jurisdiction, under the
circumstances, the 50% surcharge imposed in the deficiency assessment should be deleted. 7

The Commissioner of Internal Revenue, not satisfied with the respondent CTA's ruling, elevated the
matter to us, by the present petition, raising the main issue as to:

WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY? 8

On the other hand, Javier candidly stated in his Memorandum,  that he "did not appeal the decision
9

which held him liable for the basic deficiency income tax (excluding the 50% surcharge for fraud)."
However, he submitted in the same memorandum "that the issue may be raised in the case not for
the purpose of correcting or setting aside the decision which held him liable for deficiency income
tax, but only to show that there is no basis for the imposition of the surcharge." This subsequent
disavowal therefore renders moot and academic the posturings articulated in as Comment  on the
10
non-taxability of the amount he erroneously received and the bulk of which he had already
disbursed. In any event, an appeal at that time (of the filing of the Comments) would have been
already too late to be seasonable. The petitioner, through the office of the Solicitor General, stresses
that:

x x x           x x x          x x x

The record however is not ambivalent, as the record clearly shows that private respondent is
self-convinced, and so acted, that he is the beneficial owner, and of which reason is liable to
tax. Put another way, the studied insinuation that private respondent may not be the
beneficial owner of the money or income flowing to him as enhanced by the studied claim
that the amount is "subject of litigation" is belied by the record and clearly exposed as a
fraudulent ploy, as witness what transpired upon receipt of the amount.

Here, it will be noted that the excess in the amount erroneously remitted by MELLON BANK
for the amount of private respondent's wife was $999,000.00 after opening a dollar account
with Prudential Bank in the amount of $999,993.70, private respondent and his wife, with
haste and dispatch, within a span of eleven (11) electric days, specifically from June 3 to
June 14, 1977, effected a total massive withdrawal from the said dollar account in the sum of
$975,000.00 or P7,020,000.00. . . . 11

In reply, the private respondent argues:

x x x           x x x          x x x

The petitioner contends that the private respondent committed fraud by not declaring the
"mistaken remittance" in his income tax return and by merely making a footnote thereon
which read: "Taxpayer was the recipient of some money from abroad which he presumed to
be a gift but turned out to be an error and is now subject of litigation." It is respectfully
submitted that the said return was not fraudulent. The footnote was practically an invitation to
the petitioner to make an investigation, and to make the proper assessment.

The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths v. Comm.,
50 F [2d] 782), that is, it must be stronger than the "mere preponderance of evidence" which
would be sufficient to sustain a judgment on the issue of correctness of the deficiency itself
apart from the fraud penalty. (Frank A. Neddas, 40 BTA 672). The following circumstances
attendant to the case at bar show that in filing the questioned return, the private respondent
was guided, not by that "willful and deliberate intent to prevent the Government from making
a proper assessment" which constitute fraud, but by an honest doubt as to whether or not
the "mistaken remittance" was subject to tax.

First, this Honorable Court will take judicial notice of the fact that so-called "million dollar
case" was given very, very wide publicity by media; and only one who is not in his right mind
would have entertained the idea that the BIR would not make an assessment if the amount
in question was indeed subject to the income tax.

Second, as the respondent Court ruled, "the question involved in this case is of first
impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even in the United
States, the authorities are not unanimous in holding that similar receipts are subject to the
income tax. It should be noted that the decision in the Rutkin case is a five-to-four decision;
and in the very case before this Honorable Court, one out of three Judges of the respondent
 Court was of the opinion that the amount in question is not taxable. Thus, even without the
footnote, the failure to declare the "mistaken remittance" is not fraudulent.

Third, when the private respondent filed his income tax return on March 15, 1978 he was
being sued by the Mellon Bank for the return of the money, and was being prosecuted by the
Government for estafa committed allegedly by his failure to return the money and by
converting it to his personal benefit. The basic tax amounted to P4,899,377.00 (See p. 6 of
the Petition) and could not have been paid without using part of the mistaken remittance.
Thus, it was not unreasonable for the private respondent to simply state in his income tax
return that the amount received was still under litigation. If he had paid the tax, would that
not constitute estafa for using the funds for his own personal benefit? and would the
Government refund it to him if the courts ordered him to refund the money to the Mellon
Bank? 12

x x x           x x x          x x x

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National Internal Revenue
Code), a taxpayer who files a false return is liable to pay the fraud penalty of 50% of the tax due
from him or of the deficiency tax in case payment has been made on the basis of the return filed
before the discovery of the falsity or fraud.

We are persuaded considerably by the private respondent's contention that there is no fraud in the
filing of the return and agree fully with the Court of Tax Appeals' interpretation of Javier's notation on
his income tax return filed on March 15, 1978 thus: "Taxpayer was the recipient of some money from
abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation
that it was an "error or mistake of fact or law" not constituting fraud, that such notation was
practically an invitation for investigation and that Javier had literally "laid his cards on the table."
13

In Aznar v. Court of Tax Appeals,  fraud in relation to the filing of income tax return was discussed in
14

this manner:

. . . The fraud contemplated by law is actual and not constructive. It must be intentional fraud,
consisting of deception willfully and deliberately done or resorted to in order to induce
another to give up some legal right. Negligence, whether slight or gross, is not equivalent to
the fraud with intent to evade the tax contemplated by law. It must amount to intentional
wrong-doing with the sole object of avoiding the tax. It necessarily follows that a mere
mistake cannot be considered as fraudulent intent, and if both petitioner and respondent
Commissioner of Internal Revenue committed mistakes in making entries in the returns and
in the assessment, respectively, under the inventory method of determining tax liability, it
would be unfair to treat the mistakes of the petitioner as tainted with fraud and those of the
respondent as made in good faith.

Fraud is never imputed and the courts never sustain findings of fraud upon circumstances which, at
most, create only suspicion and the mere understatement of a tax is not itself proof of fraud for the
purpose of tax evasion. 15

A "fraudulent return" is always an attempt to evade a tax, but a merely "false return" may not
be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16

In the case at bar, there was no actual and intentional fraud through willful and deliberate misleading
of the government agency concerned, the Bureau of Internal Revenue, headed by the herein
petitioner. The government was not induced to give up some legal right and place itself at a
disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities because
Javier did not conceal anything. Error or mistake of law is not fraud. The petitioner's zealousness to
collect taxes from the unearned windfall to Javier is highly commendable.  Unfortunately, the
1âwphi1

imposition of the fraud penalty in this case is not justified by the extant facts. Javier may be guilty of
swindling charges, perhaps even for greed by spending most of the money he received, but the
records lack a clear showing of fraud committed because he did not conceal the fact that he had
received an amount of money although it was a "subject of litigation." As ruled by respondent Court
of Tax Appeals, the 50% surcharge imposed as fraud penalty by the petitioner against the private
respondent in the deficiency assessment should be deleted.

WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax Appeals is
AFFIRMED. No costs.

[ G.R. No. 167679, July 22, 2015 ]

ING BANK N.V., ENGAGED IN BANKING OPERATIONS IN THE PHILIPPINES AS
ING BANK N.V. MANILA BRANCH, PETITIONER, VS. COMMISSIONER OF
INTERNAL REVENUE, RESPONDENT.

DECISION
LEONEN, J.:
Qualified taxpayers with pending tax cases may still avail themselves of the tax amnesty
program under Republic Act No. 9480,[1] otherwise known as the 2007 Tax Amnesty Act. Thus,
the provision in BIR Revenue Memorandum Circular No. 19-2008 excepting "[i]ssues and cases
which were ruled by any court (even without finality) in favor of the BIR prior to amnesty
availment of the taxpayer" from the benefits of the law is illegal, invalid, and null and void.
[2]
 The duty to withhold the tax on compensation arises upon its accrual.

This is a Petition for Review[3] appealing the April 5, 2005 Decision[4] of the Court of Tax
Appeals En Banc, which in turn affirmed the August 9, 2004 Decision [5] and November 12, 2004
Resolution[6] of the Court of Tax Appeals Second Division. The August 9, 2004 Decision held
petitioner ING Bank, N.V. Manila Branch (ING Bank) liable for (a) deficiency documentary
stamp tax for the taxable years 1996 and 1997 in the total amount of P238,545,052.38
inclusive of surcharges; (b) deficiency onshore tax for the taxable year 1996 in the total
amount of P997,333.89 inclusive of surcharges and interest; and (c) deficiency withholding tax
on compensation for the taxable years 1996 and 1997 in the total amount of P564,542.67
inclusive of interest. The Resolution denied ING Bank's Motion for Reconsideration. [7]

While this case was pending before this court, ING Bank filed a Manifestation and
Motion[8] stating that it availed itself of the government's tax amnesty program under Republic
Act No. 9480 with respect to its deficiency documentary stamp tax and deficiency onshore tax
liabilities.[9] What is at issue now is whether ING Bank is entitled to the immunities and
privileges under Republic Act No. 9480, and whether the assessment for deficiency
withholding tax on compensation is proper.

ING Bank, "the Philippine branch of Internationale Nederlanden Bank N.V., a foreign banking
corporation incorporated in the Netherlands[,] is duly authorized by the Bangko Sentral ng
Pilipinas to operate as a branch with full banking authority in the Philippines." [10]

On January 3, 2000, ING Bank received a Final Assessment Notice [11] dated December 3, 1999.
[12]
 The Final Assessment Notice also contained the Details of Assessment [13] and 13
Assessment Notices issued by the Enforcement Service of the Bureau of Internal Revenue
through its Assistant Commissioner Percival T. Salazar[.][14] The Final Assessment Notice
covered the following deficiency tax assessments for taxable years 1996 and 1997: [15]

Particulars Basic Tax (P) Surcharge (P) Interest (P) Total (P)
         
Deficiency Income Tax        
1996 (ST-INC-96-0174-99) 20,916,785.03 11,346,639.55 32,263,424.58
1997 (ST-INC-97-0185-99) 133,533,114.54 45,730,518.68 179,263,633.22
 
Deficiency Withholding
Tax on Compensation
1996 (ST-WC-96-0175-99) 1,027,267.20 602,288.17 1,629,555.37
1997 (ST-WC-97-0184-99) 2,505,925.25 968,042.36 3,473,967.61
 
Deficiency Onshore Tax
1996 (ST-OT-96-0176-99) 8,267,437.54 4,847,209.95 13,114,647.49
 
Deficiency Branch Profit
Remittance Tax
1996 (ST-RT-96-0177-99) 39,215,700.00 22,992,218[.]63 62,207,918.63
1997 (ST-RT-97-0181-99) 92,587,381.60 6,729,180.18 40,799,690.39 140,116,252.17
 
Deficiency Documentary
Stamp Tax
1996 (ST-DST-96-0178-99 3,838,753.06 959,688.27 4,798,441.33
1997 (ST-DST-97-0181-99) 1,569,990.18 392,497.55 1,962,487.73
46,749,322.2
1997 (ST-DST-97-0180-99) 186,997,288.84 233,746,611.05
1
 
Compromise Penalty
1996 (ST-CP-96-0179-99) 1,000.00 1,000.00
1997 (ST-CP-97-0186-99) 1,000.00 1,000.00
 
Deficiency Final Tax
1997 (ST-FT-97-0183-99) 53,200.89 20,551.58 73,752.47
54.830.688.2
TOTALS 490.514.844.13 127.307.159.31 672.652.691.65
1
On February 2, 2000, ING Bank "paid the deficiency assessments for [the] 1996 compromise
penalty, 1997 deficiency documentary stamp tax and 1997 deficiency final tax in the
respective amounts of P1,000.00, P1,000.00 and P75,013.25 [the original amount of P73,752.47
plus additional interest]."[16] ING Bank, however, "protested [on the same day] the remaining
ten (10) deficiency tax assessments in the total amount of P672,576,939.18." [17]

ING Bank filed a Petition for Review before the Court of Tax Appeals on October 26, 2000. This
case was docketed as C.T.A. Case No. 6187.[18] The Petition was filed to seek "the
cancellation and withdrawal of the deficiency tax assessments for the years 1996 and 1997,
including the alleged deficiency documentary stamp tax on special savings accounts,
deficiency onshore tax, and deficiency withholding tax on compensation mentioned above." [19]

After trial, the Court of Tax Appeals Second Division rendered its Decision on August 9, 2004,
with the following disposition:
WHEREFORE, the assessments for 1996 and 1997 deficiency income tax, 1996 and 1997
deficiency branch profit remittance tax and 1997 deficiency documentary stamp tax on IBCLs
exceeding five days are hereby CANCELLED and WITHDRAWN. However, the assessments for
1996 and 1997 deficiency withholding tax on compensation, 1996 deficiency onshore tax and
1996 and 1997 deficiency documentary stamp tax on special savings accounts are hereby
UPHELD in the following amounts:

Particulars Basic Tax Surcharge Interest Total

Deficiency
Withholding Tax on  
Compensation
1996 (ST-WC-96- P 105,939.86 P 61,445.11 P 167,384.97
 0175-99)
1997 (ST-WC-97-
  287,795.44 109,362.26 397,157.70
0184-99)
Deficiency Onshore
Tax
1996 (ST-OT-96-
  544,991.20 P 136,247.80 316,094.89 997,333.89
0176-99)
Deficiency
Documentary
Stamp Tax
1996 (ST-DST-96-
  3,838,753.06 959,688.27 4,798,441.33
0178-99)
1997 (ST-DST-97-
  186,997,288.84 46,749,322.21 233,746,611.05
0180-99)
P
TOTALS P 191,774,768.40 P 47,845,258.28 P 486,902.26
240,106,928.94
Accordingly, petitioner is ORDERED to PAY the respondent the aggregate amount of
P240,106,928.94, plus 20% delinquency interest per annum from February 3, 2000 until fully
paid, pursuant to Section 249(C) of the National Internal Revenue Code of 1997.

SO ORDERED.[20] (Emphasis in the original)

Both the Commissioner of Internal Revenue and ING Bank filed their respective Motions for
Reconsideration.[21] Both Motions were denied through the Second Division's Resolution dated
November 12, 2004, as follows:
WHEREFORE, the respondent's Motion for Partial Reconsideration and the petitioner's Motion
for Reconsideration are hereby DENIED for lack of merit. The pronouncement reached in the
assailed decision is REITERATED.

SO ORDERED.[22]
On December 8, 2004, ING Bank filed its appeal before the Court of Tax Appeals En Banc.
[23]
 The Court of Tax Appeals En Banc denied due course to ING Bank's Petition for Review and
dismissed the same for lack of merit in the Decision promulgated on April 5, 2005. [24]

Hence, ING Bank filed its Petition for Review[25] before this court. The Commissioner of
Internal Revenue filed its Comment[26] on October 5, 2005 and ING Bank its Reply[27] on
December 14, 2005. Pursuant to this court's Resolution[28] dated January 25, 2006, the
Commissioner of Internal Revenue filed its Manifestation and Motion [29] on February 14, 2006,
stating that it is adopting its Comment as its Memorandum, and ING Bank filed its
Memorandum[30] on March 9, 2006.

On December 20, 2007, ING Bank filed a Manifestation and Motion [31] informing this court that
it had availed itself of the tax amnesty authorized and granted under Republic Act No. 9480
covering "all national internal revenue taxes for the taxable year 2005 and prior years, with or
without assessments duly issued therefor, that have remained unpaid as of December 31,
2005 [,]"[32] ING Bank stated that it filed before the Bureau of Internal Revenue its Notice of
Availment of Tax Amnesty Under Republic Act No. 9480[33] on December 14, 2007, together
with the following documents:

(1) Statement of Assets, Liabilities and Net Worth (SALN) as of December 31, 2005 (original
and amended declarations);[34]
(2) Tax Amnesty Return For Taxable Year 2005 and Prior Years (BIRFormNo. 2116);[35] and

(3) Tax Amnesty Payment Form (Acceptance of Payment Form) for Taxable Year 2005 and
Prior Years (BIR Form No. 0617)[36] showing payment of the amnesty tax in the amount of
P500,000.00.

ING Bank prayed that this court issue a resolution taking note of its availment of the tax
amnesty, and confirming its entitlement to all the immunities and privileges under Section 6 of
Republic Act No. 9480, particularly with respect to the "payment of deficiency documentary
stamp taxes on its special savings accounts for the taxable years 1996 and 1997 and
deficiency tax on onshore interest income derived under the foreign currency deposit system
for taxable year 1996[.]"[37]

Pursuant to this court's Resolution[38] dated January 23, 2008, the Commissioner of Internal
Revenue filed its Comment[39] and ING Bank, its Reply.[40]

Originally, ING Bank raised the following issues in its pleadings:

First, whether "[t]he Court of Tax Appeals En Banc erred in concluding that petitioner's
Special Saving Accounts are subject to documentary stamp tax (DST) as certificates of
deposit under Section 180 of the 1977 Tax Code";[41]

Second, whether "[t]he Court of Tax Appeals En Banc erred in holding petitioner liable for
deficiency onshore tax considering that under the 1977 Tax Code and the pertinent revenue
regulations, the obligation to pay the ten percent (10%) final tax on onshore interest income
rests on the payors-borrowers and not on petitioner as payee-lender"; [42] and

Third, whether "[t]he Court of Tax Appeals En Banc erred in holding petitioner liable for
deficiency withholding tax on compensation for the accrued bonuses in the taxable years
1996 and 1997 considering that these were not distributed to petitioner's officers and
employees during those taxable years, hence, were not yet subject to withholding tax." [43]

However, ING Bank availed itself of the tax amnesty under Republic Act No. 9480, with
respect to its liabilities for deficiency documentary stamp taxes on its special savings
accounts for the taxable years 1996 and 1997 and deficiency tax on onshore interest income
under the foreign currency deposit system for taxable year 1996.

Consequently, the issues now for resolution are:

First, whether petitioner ING Bank may validly avail itself of the tax amnesty granted by
Republic Act No. 9480; and

Second, whether petitioner ING Bank is liable for deficiency withholding tax on accrued
bonuses for the taxable years 1996 and 1997.

Tax amnesty availment

Petitioner ING Bank asserts that it is "qualified to avail of the tax amnesty under Section 5 [of
Republic Act No. 9480] and not disqualified under Section 8 [of the same law]." [44]
Respondent Commissioner of Internal Revenue, for its part, does not deny the authenticity of
the documents submitted by petitioner ING Bank or dispute the payment of the amnesty tax.
However, respondent Commissioner of Internal Revenue claims that petitioner ING Bank is not
qualified to avail itself of the tax amnesty granted under Republic Act No. 9480 because both
the Court of Tax Appeals En Banc and Second Division ruled in its favor that confirmed the
liability of petitioner ING Bank for deficiency documentary stamp taxes, onshore taxes, and
withholding taxes.[45]

Respondent Commissioner of Internal Revenue asserts that BIR Revenue Memorandum

Circular No. 19-2008 specifically excludes "cases which were ruled by any court (even without
finality) in favor of the BIR prior to amnesty availment of the taxpayer" from the coverage of
the tax amnesty under Republic Act No. 9480.[46] In any case, respondent Commissioner of
Internal Revenue argues that petitioner ING Bank's availment of the tax amnesty is still
subject to its evaluation,[47] that it is "empowered to exercise [its] sound discretion in the
implementation of a tax amnesty in favor of a taxpayer,"[48] and "petitioner cannot presume
that its application . . . would be granted[.]"[49] Accordingly, respondent Commissioner of
Internal Revenue prays that "petitioner [ING Bank's] motion be denied for lack of merit." [50]

Petitioner ING Bank counters that BIR Revenue Memorandum Circular No. 19-2008 cannot
override Republic Act No. 9480 and its Implementing Rules and Regulations, which only
exclude from tax amnesty "tax cases subject of final and [executory] judgment by the
courts."[51]

Petitioner ING Bank asserts that its full compliance with the conditions prescribed in Republic
Act No. 9480 (the conditions being submission of the requisite documents and payment of the
amnesty tax), which respondent Commissioner of Internal Revenue does not dispute, confirms
that it is "qualified to avail itself, and has actually availed itself, of the tax amnesty." [52] It
argues that there is nothing in the law that gives respondent Commissioner of Internal
Revenue the discretion to rescind or erase the legal effects of its tax amnesty availment.
[53]
 Thus, the issue is no longer about whether "[it] is entitled to avail itself of the tax
amnesty[,]"[54] but rather whether the effects of its tax amnesty availment extend to the
assessments of deficiency documentary stamp taxes on its special savings accounts for 1996
and 1997 and deficiency tax on onshore interest income for 1996. [55]

Petitioner ING Bank points out the Court of Tax Appeals' ruling in Metropolitan Bank and
Trust Company v. Commissioner of Internal Revenue,[56] to the effect that full compliance with
the requirements of the tax amnesty law extinguishes the tax deficiencies subject of the
amnesty availment.[57] Thus, with its availment of the tax amnesty and full compliance with all
the conditions prescribed in the statute, petitioner ING Bank asserts that it is entitled to all
the immunities and privileges under Section 6 of Republic Act No. 9480. [58]

Withholding tax on compensation

Petitioner ING Bank claims that it is not liable for withholding taxes on bonuses accruing to its
officers and employees during taxable years 1996 and 1997. [59] It maintains its position that
the liability of the employer to withhold the tax does not arise until such bonus is actually
distributed. It cites Section 72 of the 1977 National Internal Revenue Code, which states that
"[e]very employer making payment of wages shall deduct and withhold upon such wages a
tax," and BIR Ruling No. 555-88 (November 23, 1988) declaring that "[t]he withholding tax on
the bonuses should be deducted upon the distribution of the same to the officers and
employees[.]"[60] ( Since the supposed bonuses were not distributed to the officers and
employees in 1996 and 1997 but were distributed in the succeeding year when the amounts of
the bonuses were finally determined, petitioner ING Bank asserts that its duty as employer to
withhold the tax during these taxable years did not arise.[61]
Petitioner ING Bank further argues that the Court of Tax Appeals' discussion on Section 29(j)
of the 1993 National Internal Revenue Code and Section 3 of Revenue Regulations No. 8-90 is
not applicable because the issue in this case "is not whether the accrued bonuses should be
allowed as deductions from petitioner's taxable income but, rather, whether the accrued
bonuses are subject to withholding tax on compensation in the respective years of
accrual[.]"[62]

Respondent Commissioner of Internal Revenue counters that petitioner ING Bank's application
of BIR Ruling No. 555-88 is misplaced because as found by the Second Division of the Court of
Tax Appeals, the factual milieu is different:[63]
In that ruling, bonuses are determined and distributed in the succeeding year "[A]fter [sic] the
audit of each company is completed (on or before April 15 of the succeeding year)". The
withholding and remittance of income taxes were also made in the year they were distributed
to the employees. . . .

In petitioner's case, bonuses were determined during the year but were distributed in the
succeeding year. No withholding of income tax was effected but the bonuses were claimed as
an expense for the year. . . .

Since the bonuses were not subjected to withholding tax during the year they were claimed as
an expense, the same should be disallowed pursuant to the above-quoted law. [64]
Respondent Commissioner of Internal Revenue contends that petitioner ING Bank's act of
"claim[ing] [the] subject bonuses as deductible expenses in its taxable income although it has
not yet withheld and remitted the [corresponding withholding] tax" [65] to the Bureau of Internal
Revenue contravened Section 29(j) of the 1997 National Internal Revenue Code, as amended.
[66]
 Respondent Commissioner of Internal Revenue claims that "subject bonuses should also
be disallowed as deductible expenses of petitioner."[67]

Taxpayers with pending tax cases may avail themselves of the tax amnesty program under
Republic Act No. 9480.

In CS Garment, Inc. v. Commissioner of Internal Revenue,[68] this court has "definitively

declare[d] . . . the exception '[i]ssues and cases which were ruled by any court (even without
finality) in favor of the BIR prior to amnesty availment of the taxpayer' under BIR [Revenue
Memorandum Circular No.] 19-2008 [as] invalid, [for going] beyond the scope of the provisions
of the 2007 Tax Amnesty Law."[69] Thus:
[N]either the law nor the implementing rules state that a court ruling that has not attained
finality would preclude the availment of the benefits of the Tax Amnesty Law. Both R.A. 9480
and DOF Order No. 29-07 are quite precise in declaring that "[t]ax cases subject of final and
executory judgment by the courts" are the ones excepted from the benefits of the law. In fact,
we have already pointed out the erroneous interpretation of the law in Philippine Banking
Corporation (Now: Global Business Bank, Inc.) v. Commissioner of Internal Revenue, viz :
The BIR's inclusion of "issues and cases which were ruled by any court (even without finality)
in favor of the BIR prior to amnesty availment of the taxpayer" as one of the exceptions in
RMC 19-2008 is misplaced. RA 9480 is specifically clear that the exceptions to the tax
amnesty program include "tax cases subject of final and executory judgment by the courts."
The present case has not become final and executory when Metrobank availed of the tax
amnesty program.[70] (Emphasis in the original, citation omitted)
Moreover, in the fairly recent case of LG Electronics Philippines, Inc. v. Commissioner of
Internal Revenue,[71] we confirmed that only cases that involve final and executory judgments
are excluded from the tax amnesty program as explicitly provided under Section 8 of Republic
Act No. 9480.[72]

Thus, petitioner ING Bank is not disqualified from availing itself of the tax amnesty under the
law during the pendency of its appeal before this court.

II

Petitioner ING Bank showed that it complied with the requirements set forth under Republic
Act No. 9480. Respondent Commissioner of Internal Revenue never questioned or rebutted
that petitioner ING Bank fully complied with the requirements for tax amnesty under the law.
Moreover, the contestability period of one (1) year from the time of petitioner ING Bank's
availment of the tax amnesty law on December 14, 2007 lapsed. Correspondingly, it is fully
entitled to the immunities and privileges mentioned under Section 6 of Republic Act No. 9480.
This is clear from the following provisions:
SEC. 2. Availment of the Amnesty. - Any person, natural or juridical, who wishes to avail
himself of the tax amnesty authorized and granted under this Act shall file with the Bureau of
Internal Revenue (BIR) a notice and Tax Amnesty Return accompanied by a Statement of
Assets, Liabilities and Networth (SALN) as of December 31, 2005, in such form as may be
prescribed in the implementing rules and regulations (IRR) of this Act, and pay the applicable
amnesty tax within six months from the effectivity of the IRR.

SEC. 4. Presumption of Correctness of the SALN. - The SALN as of December 31. 2005 shall be
considered as true and correct except where the amount of declared networth is understated
to the extent of thirty percent (30%) or more as may be established in proceedings initiated
by, or at the instance of, parties other than the BIR or its agents: Provided, That such
proceedings must be initiated within one year following the date of the filing of the tax
amnesty return and the SALN. Findings of or admission in congressional hearings, other
administrative agencies of government, and/or courts shall be admissible to prove a thirty
percent (30%) under-declaration.

SEC. 6. Immunities and Privileges. - Those who availed themselves of the tax amnesty under
Section 5 hereof and have fully complied with all its conditions shall be entitled to the
following immunities and privileges:
a. The taxpayer shall be immune from the payment of taxes, as well as addition thereto,
and the appurtenant civil, criminal or administrative penalties under the National Internal
Revenue Code of 1997, as amended, arising from, the failure to pay any and all internal
revenue taxes for taxable year 2005 and prior years.

b. The taxpayer's Tax Amnesty Returns and the SALN as of December 31, 2005 shall not
be admissible as evidence in all proceedings that pertain to taxable year 2005 and prior
years, insofar as such proceedings relate to internal revenue taxes, before judicial, quasi-
judicial or administrative bodies in which he is a defendant or respondent, and except for
the purpose of ascertaining the networth beginning January 1. 2006, the same shall not be
examined, inquired or looked into by any person or government office. However, the
taxpayer may use this as a defense, whenever appropriate, in cases brought against him.

c. The books of accounts and other records of the taxpayer for the years covered by the
tax amnesty availed of shall not be examined: Provided, That the Commissioner of Internal
Revenue may authorize in writing the examination of the said books of accounts and other
records to verify the validity or correctness of a claim for any tax refund, tax credit (other
than refund or credit of taxes withheld on wages), tax incentives, and/or exemptions under
existing laws. (Emphasis supplied)
Contrary to respondent Commissioner of Internal Revenue's stance, Republic Act No. 9480
confers no discretion on respondent Commissioner of Internal Revenue. The provisions of the
law are plain and simple. Unlike the power to compromise or abate a taxpayer's liability under
Section 204[73] of the 1997 National Internal Revenue Code that is within the discretion of
respondent Commissioner of Internal Revenue,[74] its authority under Republic Act No. 9480 is
limited to determining whether (a) the taxpayer is qualified to avail oneself of the tax amnesty;
(b) all the requirements for availment under the law were complied with; and (c) the correct
amount of amnesty tax was paid within the period prescribed by law. There is nothing in
Republic Act No. 9480 which can be construed as authority for respondent Commissioner of
Internal Revenue to introduce exceptions and/or conditions to the coverage of the law nor to
disregard its provisions and substitute his own personal judgment.

Republic Act No. 9480 provides a general grant of tax amnesty subject only to the
cases specifically excepted by it. A tax amnesty "partakes of an absolute . . . waiver by the
Government of its right to collect what otherwise would be due it[.]" [75] The effect of a
qualified taxpayer's submission of the required documents and the payment of the prescribed
amnesty tax was immunity from payment of all national internal revenue taxes as well as all
administrative, civil, and criminal liabilities founded upon or arising from non-payment of
national internal revenue taxes for taxable year 2005 and prior taxable years. [76]

Finally, the documentary stamp tax and onshore income tax are covered by the tax amnesty
program under Republic Act No. 9480 and its Implementing Rules and Regulations.
[77]
 Moreover, as to the deficiency tax on onshore interest income, it is worthy to state that
petitioner ING Bank was assessed by respondent Commissioner of Internal Revenue, not as a
withholding agent, but as one that was directly liable for the tax on onshore interest income
and failed to pay the same.

Considering petitioner ING Bank's tax amnesty availment, there is no more issue regarding its
liability for deficiency documentary stamp taxes on its special savings accounts for 1996 and
1997 and deficiency tax on onshore interest income for 1996, including surcharge and
interest.

III.

The Court of Tax Appeals En Banc affirmed the factual finding of the Second Division that
accrued bonuses were recorded in petitioner ING Bank's books as expenses for taxable years
1996 and 1997, although no withholding of tax was effected:
With the preceding defense notwithstanding, petitioner now maintained that the portion of the
disallowed bonuses in the amounts of P3,879,407.85 and P9,004,402.63 for the respective
years 1996 and 1997, were actually payments for reimbursements of representation, travel
and entertainment expenses of its officers. These expenses according to petitioner are not
considered compensation of employees and likewise not subject to withholding tax.

In order to prove that the discrepancy in the accrued bonuses represents reimbursement of
expenses, petitioner availed of the services of an independent CPA pursuant to CTA Circular
No. 1-95, as amended. As a consequence, Mr. Ruben Rubio was commissioned by the court to
verify the accuracy of petitioner's position and to check its supporting documents.

In a report dated January 29, 2002. the commissioned independent CPA noted the following
pertinent findings: . . .

Findings and Observations 1997 1996

Supporting document is under the name of the
P 930,307.56 P 1,849,040.70
employee
Supporting document is not under the name of
the Bank nor its employees (addressee is
537,456.37 53,384.80
"cash"/blank)
Supporting document is under the name of the
7,039,976.36 1,630,292.14
Bank
Supporting document is in the name of another
person (other than the employee claiming the
362,919.59 62,615.91
expense)
Supporting document is not dated within the
13,404.00 423,199.07
period (i.e., 1996 and 1997)
Date/year of transaction is not indicated 31,510.00 26,126.49
Amount is not supported by liquidation
313,319.09 935,044.28
document(s)
TOTAL P9,228,892.97 P4,979,703.39

Based on the above report, only the expenses in the name of petitioner's employee and those
under its name can be given credence. Therefore, the following expenses are valid expenses
for income tax purposes:

  1996 1997
Supporting document is under the name of the
P 1,849,040.70 P 930,307.56
employee
Supporting document is under the name of the
1,630,292.14 7,039,976.36
Bank
TOTAL P3,479,332.84 P 7,970,283.92

Consequently, petitioner is still liable for the amounts of P167,384.97 and P397,157.70
representing deficiency withholding taxes on compensation for the respective years of 1996
and 1997, computed as follows:

    1996 1997
Total Disallowed Accrued Bonus P 3,879,407.85 P 9,004,402.63
Less: Substantiated
  Reimbursement of Expense 3,479,332.84 7,970.283.92
Unsubstantiated P 400,075.01 P 1,034,119.43
Tax Rate 26.48% 27.83%
Basic Withholding Tax Due
  Thereon P 105,939.86 P 287,795.44
Interest (Sec. 249) 61,445.11 109,362.26
Deficiency Withholding Tax on
P 167,384.97 P 397,157.70[78]
Compensation
An expense, whether the same is paid ox payable, "shall be allowed as a deduction only if it is
shown that the tax required to be deducted and withheld therefrom [was] paid to the Bureau
of Internal Revenue[.]"[79]

Section 29(j) of the 1977 National Internal Revenue Code [80] (now Section 34(K) of the 1997
National Internal Revenue Code) provides:
Section 29. Deductions from gross income. — In computing taxable income subject to tax
under Sec. 21 (a); 24 (a), (b) and (c); and 25 (a) (1), there shall be allowed as deductions the
items specified in paragraphs (a) to (i) of this section:
(a) Expenses. — (1) Business expenses. — (A) In general. — All ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business, including a reasonable allowance for salaries or other compensation for personal
services actually rendered; travelling expenses while away from home in the pursuit of a
trade, profession or business, rentals or other payments required to be made as a condition to
the continued use or possession, for the purpose of the trade, profession or business, of
property to which the taxpayer has not taken or is not taking title or in which he has no equity.

(j) Additional requirement for deducibility of certain payments . — Any amount  paid or
payable  which is otherwise deductible from, or taken into account in computing gross
income for which depreciation or amortization may be allowed under this section, shall be
allowed as a deduction only if it is shown that the tax required to be deducted and withheld
therefrom has been paid to the Bureau of Internal Revenue in accordance with this section,
Sections 51[81]  and 74[82] of this Code. (Emphasis supplied)
Section 3 of Revenue Regulations No. 8-90 (now Section 2.58.5 of Revenue Regulations No. 2-
98) provides:
Section 3. Section 9 of Revenue Regulations No. 6-85 is hereby amended to read as follows:

Section 9. (a) Requirement for deductibility. Any income payment, which is otherwise

deductible under Sections 29 and 54 of the Tax Code, as amended, shall be allowed as a
deduction from the payor s gross income only if it is shown that the tax required to be
withheld has been paid to the Bureau of Internal Revenue in accordance with Sections 50, 51,
72, and 74 also of the Tax Code. (Emphasis supplied)
Under the National Internal Revenue Code, every form of compensation for personal services
is subject to income tax and, consequently, to withholding tax. The term "compensation"
means all remunerations paid for services performed by an employee for his or her employer,
whether paid in cash or in kind, unless specifically excluded under Sections 32(B) [83] and 78(A)
[84]
 of the 1997 National Internal Revenue Code.[85] The name designated to the remuneration
for services is immaterial. Thus, "salaries, wages, emoluments and honoraria, bonuses,
allowances (such as transportation, representation, entertainment, and the like), [taxable]
fringe benefits [,] pensions and retirement pay, and other income of a similar nature constitute
compensation income"[86] that is taxable.

Hence, petitioner ING Bank is liable for the withholding tax on the bonuses since it claimed
the same as expenses in the year they were accrued.

Petitioner ING Bank insists, however, that the bonus accruals in 1996 and 1997 were not yet
subject to withholding tax because these bonuses were actually distributed only in the
succeeding years of their accrual (i.e., in 1997 and 1998) when the amounts were finally
determined.

Petitioner ING Bank's contention is untenable.

The tax on compensation income is withheld at source under the creditable withholding tax
system wherein the tax withheld is intended to equal or at least approximate the tax due of
the payee on the said income. It was designed to enable (a) the individual taxpayer to meet
his or her income tax liability on compensation earned; and (b) the government to collect at
source the appropriate taxes on compensation.[87] Taxes withheld are creditable in nature.
[88]
 Thus, the employee is still required to file an income tax return to report the income and/or
pay the difference between the tax withheld and the tax due on the income. [89] For over
withholding, the employee is refunded.[90] Therefore, absolute or exact accuracy in the
determination of the amount of the compensation income is not a prerequisite for the
employer's withholding obligation to arise.

It is true that the law and implementing regulations require the employer to deduct and pay
the income tax on compensation paid to its employees, either actually or constructively.

Section 72 of the 1977 National Internal Revenue Code, as amended, [91] states:

SECTION 72. Income tax collected at source. — (a) Requirement of withholding. — Every
employer making payment of wages shall deduct and withhold, upon such wages a tax
determined in accordance with regulations to be prepared and promulgated by the Minister of
Finance. (Emphasis supplied)
Sections 7 and 14 of Revenue Regulations No. 6-82,[92] as amended,[93] relative to the
withholding of tax on compensation income, provide:
Section 7. Requirement of withholding. — Every employer or any person who pays or controls
the payment of compensation to an employee, whether resident citizen or alien, non-resident
citizen, or nonresident alien engaged in trade or business in the Philippines, must withhold
from such compensation paid, an amount computed in accordance with these regulations.

I. Withholding of tax on compensation paid to resident employees. — (a) In general, every

employer making payment of compensation shall deduct and withhold from such
compensation income for the entire calendar year, a tax determined in accordance with the
prescribed new Withholding Tax Tables effective January 1, 1992 (ANNEX "A") .

Section 14. Liability for the Tax. — The employer is required to collect the tax by deducting
and withholding the amount thereof from the employee's compensation as when paid, either
actually or constructively. An employer is required to deduct and withhold the tax
notwithstanding that the compensation is paid in something other than money (for example,
compensation paid in stocks or bonds) and to pay the tax to the collecting officer. If
compensation is paid in property other than money, the employer should make necessary
arrangements to ensure that the amount of the tax required to be withheld is available for
payment to the collecting officer.

Every person required to deduct and withhold the tax from the compensation of an employee
is liable for the payment of such tax whether or not collected from the employee . If, for
example, the employer deducts less than the correct amount of tax, or if he fails to deduct any
part of the tax, he is nevertheless liable for the correct amount of the tax. However, if the
employer in violation of the provisions of Chapter XI, Title II of the Tax Code fails to deduct
and withhold and thereafter the employee pays the tax, it shall no longer be collected from the
employer. Such payment does not, however, operate to relieve the employer from liability for
penalties or additions to the tax for failure to deduct and withhold within the time prescribed
by law or regulations. The employer will not be relieved of his liability for payment of the tax
required to be withheld unless he can show that the tax has been paid by the employee.

The amount of any tax withheld/collected by the employer is a special fund in trust for the
Government of the Philippines.
When the employer or other person required to deduct and withhold the tax under this Chapter
XI, Title II of the Tax Code has witliheld and paid such tax to the Commissioner of Internal
Revenue or to any authorized collecting officer, then such employer or person shall be relieved
of any liability to any person. (Emphasis supplied)
Constructive payment of compensation is further defined in Revenue Regulations No. 6-82:
Section 25. Applicability; constructive receipt of compensation.

Compensation is constructively paid within the meaning of these regulations when it is

credited to the account of or set apart for an employee so that it may be drawn upon by him at
any time although not then actually reduced to possession. To constitute payment in such a
case, the compensation must be credited or set apart for the employee without any
substantial limitation or restriction as to the time or manner of payment or condition upon
which payment is to be made, and must be made available to him so that it may be drawn
upon at any time, and its payment brought within his control and disposition. (Emphasis
supplied)
On the other hand, it is also true that under Section 45 of the 1997 National Internal Revenue
Code (then Section 39 of the 1977 National Internal Revenue Code, as amended), deductions
from gross income are taken for the taxable year in which "paid or accrued" or "paid or
incurred" is dependent upon the method of accounting income and expenses adopted by the
taxpayer.

In Commissioner of Internal Revenue v. Isabela Cultural Corporation ,[94] this court explained

the accrual method of accounting, as against the cash method:
Accounting methods for tax purposes comprise a set of rules for determining when and how to
report income and deductions.

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

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

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

The all-events test requires the right to income or liability be fixed, and the amount of such
income or liability be determined with reasonable accuracy. However, the test does not
demand that the amount of income or liability be known absolutely only that a taxpayer has at
his disposal the information necessary to compute the amount with reasonable accuracy . The
all-events test is satisfied where computation remains uncertain, if its basis is unchangeable;
the test is satisfied where a computation may be unknown, but is not as much as unknowable,
within the taxable year. The amount of liability does not have to be determined exactly; it
must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy"
implies something less than an exact or completely accurate amount. [95] (Emphasis supplied,
citations omitted)
Thus, if the taxpayer is on cash basis, the expense is deductible in the year it was paid,
regardless of the year it was incurred. If he is on the accrual method, he can deduct the
expense upon accrual thereof. An item that is reasonably ascertained as to amount and
acknowledged to be due has "accrued"; actual payment is not essential to constitute
"expense."

Stated otherwise, an expense is accrued and deducted for tax purposes when (1) the
obligation to pay is already fixed; (2) the amount can be determined with reasonable
accuracy; and, (3) it is already knowable or the taxpayer can reasonably be expected to have
known at the closing of its books for the taxable year.

Section 29(j) of the 1977 National Internal Revenue Code [96] (Section 34(K) of the 1997
National Internal Revenue Code) expressly requires, as a condition for deductibility of an
expense, that the tax required to be withheld on the amount paid or payable is shown to have
been remitted to the Bureau of Internal Revenue by the taxpayer constituted as a withholding
agent of the government.

The provision of Section 72 of the 1977 National Internal Revenue Code (Section 79 of the
1997 National Internal Revenue Code) regarding withholding on wages must be read and
construed in harmony with Section 29(j) of the 1977 National Internal Revenue Code (Section
34(K) of the 1997 National Internal Revenue Code) on deductions from gross income. This is in
accordance with the rule on statutory construction that an interpretation is to be sought
which gives effect to the whole of the statute, such that every part is made effective,
harmonious, and sensible,[97] if possible, and not defeated nor rendered insignificant,
meaningless, and nugatory.[98] If we go by the theory of petitioner ING Bank, then the
condition imposed by Section 29(j) would have been rendered nugatory, or we would in effect
have created an exception to this mandatory requirement when there was none in the law.

Reading together the two provisions, we hold that the obligation of the payor/employer to
deduct and withhold the related withholding tax arises at the time the income was paid or
accrued or recorded as an expense in the payor's/employer's books, whichever comes first.

Petitioner ING Bank accrued or recorded the bonuses as deductible expense in its books.
Therefore, its obligation to withhold the related withholding tax due from the deductions for
accrued bonuses arose at the time of accrual and not at the time of actual payment.

In Filipinas Synthetic Fiber Corporation v. Court of Appeals,[99] the issue was raised on

"whether the liability to withhold tax at source on income payments to non-resident foreign
corporations arises upon remittance of the amounts due to the foreign creditors or upon
accrual thereof."[100] In resolving this issue, this court considered the nature of the accounting
method employed by the withholding agent, which was the accrual method, wherein it was the
right to receive income, and not the actual receipt, that determined when to report the amount
as part of the taxpayer's gross income.[101] It upheld the lower court's finding that there was
already a definite liability on the part of petitioner at the maturity of the loan contracts.
[102]
 Moreover, petitioner already deducted as business expense the said amounts as interests
due to the foreign corporation.[103] Consequently, the taxpayer could not claim that there was
"no duty to withhold and remit income taxes as yet because the loan contract was not yet due
and demandable."[104] Petitioner, "[h]aving written-off the amounts as business expense in its
books, had taken advantage of the benefit provided in the law allowing for deductions from
gross income."[105]

Here, petitioner ING Bank already recognized a definite liability on its part considering that it
had deducted as business expense from its gross income the accrued bonuses due to its
employees. Underlying its accrual of the bonus expense was a reasonable expectation or
probability that the bonus would be achieved. In this sense, there was already a constructive
payment for income tax purposes as these accrued bonuses were already allotted or made
available to its officers and employees.

We note petitioner ING Bank's earlier claim before the Court of Tax Appeals that the bonus
accruals in 1996 and 1997 were disbursed in the following year of accrual, as reimbursements
of representation, travel, and entertainment expenses incurred by its employees. [106] This
shows that the accrued bonuses in the amounts of P400,075.01 (1996) and P1,034,119.43
(1997) on which deficiency withholding taxes of P167,384.97 (1996) and P397,157.70 (1997)
were imposed, respectively, were already set apart or made available to petitioner ING Bank's
officers and employees. To avoid any tax issue, petitioner ING Bank should likewise have
recognized the withholding tax liabilities associated with the bonuses at the time of accrual.

WHEREFORE, the Petition is PARTLY GRANTED. The assessments with respect to petitioner

ING Bank's liabilities for deficiency documentary stamp taxes on its special savings accounts
for the taxable years 1996 and 1997 and deficiency tax on onshore interest income under the
foreign currency deposit system for taxable year 1996 are hereby SET ASIDE solely in view of
petitioner ING Bank's availment of the tax amnesty program under Republic Act No. 9480. The
April 5, 2005 Decision of the Court of Tax Appeals En Banc, which affirmed the August 9, 2004
Decision and November 12, 2004 Resolution of the Court of Tax Appeals Second Division
holding petitioner ING Bank liable for deficiency withholding tax on compensation for the
taxable years 1996 and 1997 in the total amount of P564,542.67 inclusive of interest,
is AFFIRMED.

SECOND DIVISION

G.R. No. 169507, January 11, 2016

AIR CANADA, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

DECISION

LEONEN, J.:

An offline international air carrier selling passage tickets in the Philippines, through a
general sales agent, is a resident foreign corporation doing business in the Philippines.
As such, it is taxable under Section 28(A)(1), and not Section 28(A)(3) of the 1997
National Internal Revenue Code, subject to any applicable tax treaty to which the
Philippines is a signatory. Pursuant to Article 8 of the Republic of the Philippines-Canada
Tax Treaty, Air Canada may only be imposed a maximum tax of 1 1/2% of its gross
revenues earned from the sale of its tickets in the Philippines.

This is a Petition for Review1 appealing the August 26, 2005 Decision2 of the Court of
Tax Appeals En Banc, which in turn affirmed the December 22, 2004 Decision3 and April
8, 2005 Resolution4 of the Court of Tax Appeals First Division denying Air Canada's
claim for refund.

Air Canada is a "foreign corporation organized and existing under the laws of
Canada[.]"5 On April 24, 2000, it was granted an authority to operate as an offline
carrier by the Civil Aeronautics Board, subject to certain conditions, which authority
would expire on April 24, 2005.6 "As an off-line carrier, [Air Canada] does not have
flights originating from or coming to the Philippines [and does not] operate any airplane
[in] the Philippines[.]"7

On July 1, 1999, Air Canada engaged the services of Aerotel Ltd., Corp. (Aerotel) as its
general sales agent in the Philippines.8 Aerotel "sells [Air Canada's] passage documents
in the Philippines."9

For the period ranging from the third quarter of 2000 to the second quarter of 2002, Air
Canada, through Aerotel, filed quarterly and annual income tax returns and paid the
income tax on Gross Philippine Billings in the total amount of P5,185,676.77,10 detailed
as follows:chanRoblesvirtualLawlibrary

Applicable Quarter[/]Year Date Filed/Paid Amount of Tax

3rd Qtr 2000 November 29,2000 P 395,165.00

Annual ITR 2000 April 16, 2001 381,893.59

1st Qtr 2001 May 30,2001 522,465.39

2nd Qtr 2001 August 29,2001 1,033,423.34

3rd Qtr 2001 November 29,2001 765,021.28

Annual ITR 2001 April 15, 2002 328,193.93

1st Qtr 2002 May 30,2002 594,850.13

2nd Qtr 2002 August 29,2002 1,164,664.11

TOTAL P 5,185,676.77" cralawlawlibrary

On November 28, 2002, Air Canada filed a written claim for refund of alleged
erroneously paid income taxes amounting to P5,185,676.77 before the Bureau of
Internal Revenue,12 Revenue District Office No. 47-East Makati.13 It found basis from
the revised definition14 of Gross Philippine Billings under Section 28(A)(3)(a) of the
1997 National Internal Revenue Code: chanRoblesvirtualLawlibrary

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

....
(3) International Carrier. - An international carrier doing business in the Philippines
shall pay a tax of two and one-half percent (2 1/2%) on its 'Gross Philippine Billings' as
defined hereunder: chanRoblesvirtualLawlibrary

(a) International Air Carrier. - 'Gross Philippine Billings' refers to the amount of gross
revenue derived from carriage of persons, excess baggage, cargo and
mail originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of payment of the
ticket or passage document: Provided, That tickets revalidated, exchanged and/or
indorsed to another international airline form part of the Gross Philippine Billings if the
passenger boards a plane in a port or point in the Philippines: Provided, further, That
for a flight which originates from the Philippines, but transshipment of passenger takes
place at any port outside the Philippines on another airline, only-the aliquot portion of
the cost of the ticket corresponding to the leg flown from the Philippines to the point of
transshipment shall form part of Gross Philippine Billings. (Emphasis supplied) cralawlawlibrary

To prevent the running of the prescriptive period, Air Canada filed a Petition for Review
before the Court of Tax Appeals on November 29, 2002.15 The case was docketed as
C.T.A. Case No. 6572.16

On December 22, 2004, the Court of Tax Appeals First Division rendered its Decision
denying the Petition for Review and, hence, the claim for refund.17 It found that Air
Canada was engaged in business in the Philippines through a local agent that sells
airline tickets on its behalf. As such, it should be taxed as a resident foreign corporation
at the regular rate of 32%.18 Further, according to the Court of Tax Appeals First
Division, Air Canada was deemed to have established a "permanent establishment"19 in
the Philippines under Article V(2)(i) of the Republic of the Philippines-Canada Tax
Treaty20 by the appointment of the local sales agent, "in which [the] petitioner uses its
premises as an outlet where sales of [airline] tickets are made[.]"21

Air Canada seasonably filed a Motion for Reconsideration, but the Motion was denied in
the Court of Tax Appeals First Division's Resolution dated April 8, 2005 for lack of
merit.22 The First Division held that while Air Canada was not liable for tax on its Gross
Philippine Billings under Section 28(A)(3), it was nevertheless liable to pay the 32%
corporate income tax on income derived from the sale of airline tickets within the
Philippines pursuant to Section 28(A)(1).23

On May 9, 2005, Air Canada appealed to the Court of Tax Appeals En Bane.24 The
appeal was docketed as CTAEB No. 86.25 cralawred

In the Decision dated August 26, 2005, the Court of Tax Appeals En Bane affirmed the
findings of the First Division.26 The En Banc ruled that Air Canada is subject to tax as a
resident foreign corporation doing business in the Philippines since it sold airline tickets
in the Philippines.27 The Court of Tax Appeals En Bane disposed thus: chanRoblesvirtualLawlibrary

WHEREFORE, premises considered, the instant petition is hereby DENIED DUE

COURSE, and accordingly, DISMISSED for lack of merit.28 cralawlawlibrary

Hence, this Petition for Review29 was filed. The issues for our consideration are: chanRoblesvirtualLawlibrary

First, whether petitioner Air Canada, as an offline international carrier selling passage
documents through a general sales agent in the Philippines, is-a resident foreign
corporation within the meaning of Section 28(A)(1) of the 1997 National Internal
Revenue Code;
Second, whether petitioner Air Canada is subject to the 21/2% tax on Gross Philippine
Billings pursuant to Section 28(A)(3). If not, whether an offline international carrier
selling passage documents through a general sales agent can be subject to the regular
corporate income tax of 32% on taxable income pursuant to Section 28(A)(1);

Third, whether the Republic of the Philippines-Canada Tax Treaty applies,

specifically:
chanRoblesvirtualLawlibrary

a. Whether the Republic of the Philippines-Canada Tax Treaty is enforceable;

b. Whether the appointment of a local general sales agent in the Philippines falls
under the definition of "permanent establishment" under Article V(2)(i) of the
Republic of the Philippines-Canada Tax Treaty; and

Lastly, whether petitioner Air Canada is entitled to the refund of P5,185,676.77

pertaining allegedly to erroneously paid tax on Gross Philippine Billings from the third
quarter of 2000 to the second quarter of 2002.

Petitioner claims that the general provision imposing the regular corporate income tax
on resident foreign corporations provided under Section 28(A)(1) of the 1997 National
Internal Revenue Code does not apply to "international carriers,"31 which are especially
classified and taxed under Section 28(A)(3).32 It adds that the fact that it is no longer
subject to Gross Philippine Billings tax as ruled in the assailed Court of Tax Appeals
Decision "does not render it ipso facto subject to 32% income tax on taxable income as
a resident foreign corporation."33 Petitioner argues that to impose the 32% regular
corporate income tax on its income would violate the Philippine government's covenant
under Article VIII of the Republic of the Philippines-Canada Tax Treaty not to impose a
tax higher than 1 Vi% of the carrier's gross revenue derived from sources within the
Philippines.34 It would also allegedly result in "inequitable tax treatment of on-line and
off-line international air carriers[.]"35

Also, petitioner states that the income it derived from the sale of airline tickets in the
Philippines was income from services and not income from sales of personal
property.36 Petitioner cites the deliberations of the Bicameral Conference Committee on
House Bill No. 9077 (which eventually became the 1997 National Internal Revenue
Code), particularly Senator Juan Ponce Enrile's statement,37 to reveal the "legislative
intent to treat the revenue derived from air carriage as income from services, and that
the carriage of passenger or cargo as the activity that generates the
income."38 Accordingly, applying the principle on the situs of taxation in taxation of
services, petitioner claims that its income derived "from services rendered outside the
Philippines [was] not subject to Philippine income taxation."39

Petitioner further contends that by the appointment of Aerotel as its general sales
agent, petitioner cannot be considered to have a "permanent establishment"40 in the
Philippines pursuant to Article V(6) of the Republic of the Philippines-Canada Tax
Treaty.41 It points out that Aerotel is an "independent general sales agent that acts as
such for ... other international airline companies in the ordinary course of its
business."42 Aerotel sells passage tickets on behalf of petitioner and receives a
commission for its services.43 Petitioner states that even the Bureau of Internal
Revenue— through VAT Ruling No. 003-04 dated February 14, 2004—has conceded
that an offline international air carrier, having no flight operations to and from the
Philippines, is not deemed engaged in business in the Philippines by merely appointing
a general sales agent.44 Finally, petitioner maintains that its "claim for refund of
erroneously paid Gross Philippine Billings cannot be denied on the ground that [it] is
subject to income tax under Section 28 (A) (I)"45 since it has not been assessed at all
by the Bureau of Internal Revenue for any income tax liability.46

On the other hand, respondent maintains that petitioner is subject to the 32%
corporate income tax as a resident foreign corporation doing business in the Philippines.
Petitioner's total payment of P5,185,676.77 allegedly shows that petitioner was earning
a sizable income from the sale of its plane tickets within the Philippines during the
relevant period.47 Respondent further points out that this court in Commissioner of
Internal Revenue v. American Airlines, Inc.,48 which in turn cited the cases involving the
British Overseas Airways Corporation and Air India, had already settled that "foreign
airline companies which sold tickets in the Philippines through their local agents . . .
[are] considered resident foreign corporations engaged in trade or business in the
country."49 It also cites Revenue Regulations No. 6-78 dated April 25, 1978, which
defined the phrase "doing business in the Philippines" as including "regular sale of
tickets in the Philippines by offline international airlines either by themselves or through
their agents."50

Respondent further contends that petitioner is not entitled to its claim for refund
because the amount of P5,185,676.77 it paid as tax from the third quarter of 2000 to
the second quarter of 2001 was still short of the 32% income tax due for the
period.51 Petitioner cannot allegedly claim good faith in its failure to pay the right
amount of tax since the National Internal Revenue Code became operative on January
1, 1998 and by 2000, petitioner should have already been aware of the implications of
Section 28(A)(3) and the decided cases of this court's ruling on the taxability of offline
international carriers selling passage tickets in the Philippines.52

At the outset, we affirm the Court of Tax Appeals' ruling that petitioner, as an offline
international carrier with no landing rights in the Philippines, is not liable to tax on
Gross Philippine Billings under Section 28(A)(3) of the 1997 National Internal Revenue
Code: chanRoblesvirtualLawlibrary

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations.  -

....
(3) International Carrier. - An international carrier doing business in the Philippines
shall pay a tax of two and one-half percent (2 1/2%) on its 'Gross Philippine Billings' as
defined hereunder:
(a) International Air Carrier. - 'Gross Philippine Billings' refers to the amount of gross
revenue derived from carriage of persons, excess baggage, cargo and mail originating
from the Philippines in a continuous and uninterrupted flight, irrespective of the place
of sale or issue and the place of payment of the ticket or passage document: Provided,
That tickets revalidated, exchanged and/or indorsed to another international airline
form part of the Gross Philippine Billings if the passenger boards a plane in a port or
point in the Philippines: Provided, further, That for a flight which originates from the
Philippines, but transshipment of passenger takes place at any port outside the
Philippines on another airline, only the aliquot portion of the cost of the ticket
corresponding to the leg flown from the Philippines to the point of transshipment shall
form part of Gross Philippine Billings. (Emphasis supplied) cralawlawlibrary

Under the foregoing provision, the tax attaches only when the carriage of persons,
excess baggage, cargo, and mail originated from the Philippines in a continuous and
uninterrupted flight, regardless of where the passage documents were sold.

Not having flights to and from the Philippines, petitioner is clearly not liable for the
Gross Philippine Billings tax.

II

Petitioner, an offline carrier, is a resident foreign corporation for income tax purposes.
Petitioner falls within the definition of resident • foreign corporation under Section
28(A)(1) of the 1997 National Internal Revenue Code, thus, it may be subject to
32%53 tax on its taxable income: chanRoblesvirtualLawlibrary

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

(1) In General. - Except as otherwise provided in this Code,  a corporation organized,

authorized, or existing under the laws of any foreign country, engaged in
trade or business within the Philippines, shall be subject to an income tax
equivalent to thirty-five percent (35%) of the taxable income derived in the
preceding taxable year from all sources within the Philippines: Provided, That
effective January 1, 1998, the rate of income tax shall be thirty-four percent (34%);
effective January 1, 1999, the rate shall be thirty- three percent (33%); and effective
January 1, 2000 and thereafter, the rate shall be thirty-two percent (32%54). (Emphasis
supplied)cralawlawlibrary

The definition of "resident foreign corporation" has not substantially changed

throughout the amendments of the National Internal Revenue Code. All versions refer
to "a foreign corporation engaged in trade or business within the Philippines."

Commonwealth Act No. 466, known as the National Internal Revenue Code and
approved on June 15, 1939, defined "resident foreign corporation" as applying to "a
foreign corporation engaged in trade or business within the Philippines or having an
office or place of business therein."55

Section 24(b)(2) of the National Internal Revenue Code, as amended by Republic Act
No. 6110, approved on August 4, 1969, reads: chanRoblesvirtualLawlibrary

Sec. 24. Rates of tax on corporations. — . . .

(b) Tax on foreign corporations. — . . .

(2) Resident corporations. — A corporation organized, authorized, or existing under the

laws of any foreign country, except a foreign life insurance company, engaged in trade
or business within the Philippines, shall be taxable as provided in subsection (a) of this
section upon the total net income received in the preceding taxable year from all
sources within the Philippines.56 (Emphasis supplied) cralawlawlibrary

Presidential Decree No. 1158-A took effect on June 3, 1977 amending certain sections
of the 1939 National Internal Revenue Code. Section 24(b)(2) on foreign resident
corporations was amended, but it still provides that "[a] corporation organized,
authorized, or existing under the laws of any foreign country, engaged in trade or
business within the Philippines, shall be taxable as provided in subsection (a) of this
section upon the total net income received in the preceding taxable year from all
sources within the Philippines[.]"57

As early as 1987, this court in Commissioner of Internal Revenue v. British Overseas

Airways Corporation58 declared British Overseas Airways Corporation, an international
air carrier with no landing rights in the Philippines, as a resident foreign corporation
engaged in business in the Philippines through its local sales agent that sold and issued
tickets for the airline company.59 This court discussed that: chanRoblesvirtualLawlibrary

There is no specific criterion as to what constitutes "doing" or "engaging in" or

"transacting" business. Each case must be judged in the light of its peculiar
environmental circumstances. The term implies a continuity of commercial dealings
and arrangements, and contemplates, to that extent, the performance of acts or
works or the exercise of some of the functions normally incident to, and in
progressive prosecution of commercial gain or for the purpose and object of
the business organization. "In order that a foreign corporation may be regarded as
doing business within a State, there must be continuity of conduct and intention to
establish a continuous business, such as the appointment of a local agent, and not one
of a temporary character. ["]

BOAC, during the periods covered by the subject-assessments, maintained a general

sales agent in the Philippines. That general sales agent, from 1959 to 1971, "was
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series
of trips — each trip in the series corresponding to a different airline company; (3)
receiving the fare from the whole trip; and (4) consequently allocating to the various
airline companies on the basis of their participation in the services rendered through
the mode of interline settlement as prescribed by Article VI of the Resolution No. 850 of
the IATA Agreement." Those activities were in exercise of the functions which are
normally incident to, and are in progressive pursuit of, the purpose and object of its
organization as an international air carrier. In fact, the regular sale of tickets, its main
activity, is the very lifeWood of the airline business, the generation of sales being the
paramount objective. There should be no doubt then that BOAC was "engaged in"
business in the Philippines through a local agent during the period covered by the
assessments. Accordingly, it is a resident foreign corporation subject to tax upon its
total net income received in the preceding taxable year from all sources within the
Philippines.60 (Emphasis supplied, citations omitted) cralawlawlibrary

Republic Act No. 7042 or the Foreign Investments Act of 1991 also provides guidance
with its definition of "doing business" with regard to foreign corporations. Section 3(d)
of the law enumerates the activities that constitute doing business: chanRoblesvirtualLawlibrary

d. the phrase "doing business" shall include soliciting orders, service contracts, opening
offices, whether called "liaison" offices or branches; appointing representatives or
distributors domiciled in the Philippines or who in any calendar year stay in the country
for a period or periods totalling one hundred eighty (180) days or more; participating in
the management, supervision or control of any domestic business, firm, entity or
corporation in the Philippines; and any other act or acts that imply a continuity of
commercial dealings or arrangements, and contemplate to that extent the
performance of acts or works, or the exercise of some of the functions
normally incident to, and in progressive prosecution of, commercial gain or of
the purpose and object of the business organization: Provided, however, That'
the phrase "doing business" shall not be deemed to include mere investment as a
shareholder by a foreign entity in domestic corporations duly registered to do business,
and/or the exercise of rights as such investor; nor having a nominee director or officer
to represent its interests in such corporation; nor appointing a representative or
distributor domiciled in the Philippines which transacts business in its own name and for
its own account[.]61 (Emphasis supplied) cralawlawlibrary

While Section 3(d) above states that "appointing a representative or distributor

domiciled in the Philippines which transacts business in its own name and for its own
account" is not considered as "doing business," the Implementing Rules and
Regulations of Republic Act No. 7042 clarifies that "doing business" includes "appointing
representatives or distributors, operating under full control of the foreign
corporation, domiciled in the Philippines or who in any calendar year stay in the
country for a period or periods totaling one hundred eighty (180) days or more[.]"62

An offline carrier is "any foreign air carrier not certificated by the [Civil Aeronautics]
Board, but who maintains office or who has designated or appointed agents or
employees in the Philippines, who sells or offers for sale any air transportation in behalf
of said foreign air carrier and/or others, or negotiate for, or holds itself out by
solicitation, advertisement, or otherwise sells, provides, furnishes, contracts, or
arranges for such transportation."63

"Anyone desiring to engage in the activities of an off-line carrier [must] apply to the
[Civil Aeronautics] Board for such authority."64 Each offline carrier must file with the
Civil Aeronautics Board a monthly report containing information on the tickets sold,
such as the origin and destination of the passengers, carriers involved, and
commissions received.65

Petitioner is undoubtedly "doing business" or "engaged in trade or business" in the

Philippines.

Aerotel performs acts or works or exercises functions that are incidental and beneficial
to the purpose of petitioner's business. The activities of Aerotel bring direct receipts or
profits to petitioner.66 There is nothing on record to show that Aerotel solicited orders
alone and for its own account and without interference from, let alone direction of,
petitioner. On the contrary, Aerotel cannot "enter into any contract on behalf of
[petitioner Air Canada] without the express written consent of [the latter,]"67 and it
must perform its functions according to the standards required by petitioner.68 Through
Aerotel, petitioner is able to engage in an economic activity in the Philippines.

Further, petitioner was issued by the Civil Aeronautics Board an authority to operate as
an offline carrier in the Philippines for a period of five years, or from April 24, 2000 until
April 24, 2005.69

Petitioner is, therefore, a resident foreign corporation that is taxable on its income
derived from sources within the Philippines. Petitioner's income from sale of airline
tickets, through Aerotel, is income realized from the pursuit of its business activities in
the Philippines.

Ill

However, the application of the regular 32% tax rate under Section 28(A)(1) of the
1997 National Internal Revenue Code must consider the existence of an effective tax
treaty between the Philippines and the home country of the foreign air carrier.

In the earlier case of South African Airways v. Commissioner of Internal Revenue,70 this

court held that Section 28(A)(3)(a) does not categorically exempt all international air
carriers from the coverage of Section 28(A)(1). Thus, if Section 28(A)(3)(a) is
applicable to a taxpayer, then the general rule under Section 28(A)(1) does not apply.
If, however, Section 28(A)(3)(a) does not apply, an international air carrier would be
liable for the tax under Section 28(A)(1).71

This court in South African Airways declared that the correct interpretation of these
provisions is that: "international air carrier[s] maintaining] flights to and from the
Philippines . . . shall be taxed at the rate of 21/2% of its Gross Philippine Billings[;]
while international air carriers that do not have flights to and from the Philippines but
nonetheless earn income from other activities in the country [like sale of airline tickets]
will be taxed at the rate of 32% of such [taxable] income."72

In this case, there is a tax treaty that must be taken into consideration to determine
the proper tax rate.

A tax treaty is an agreement entered into between sovereign states "for purposes of
eliminating double taxation on income and capital, preventing fiscal evasion, promoting
mutual trade and investment, and according fair and equitable tax treatment to foreign
residents or nationals."73Commissioner of Internal Revenue v. S.C. Johnson and Son,
Inc.74 explained the purpose of a tax treaty:chanRoblesvirtualLawlibrary

The purpose of these international agreements is to reconcile the national fiscal

legislations of the contracting parties in order to help the taxpayer avoid simultaneous
taxation in two different jurisdictions. More precisely, the tax conventions are drafted
with a view towards the elimination of international juridical double taxation, which is
defined as the imposition of comparable taxes in two or more states on the same
taxpayer in respect of the same subject matter and for identical periods.

The apparent rationale for doing away with double taxation is to encourage the free
flow of goods and services and the movement of capital, technology and persons
between countries, conditions deemed vital in creating robust and dynamic economies.
Foreign investments will only thrive in a fairly predictable and reasonable international
investment climate and the protection against double taxation is crucial in creating such
a climate.75 (Emphasis in the original, citations omitted) cralawlawlibrary

Observance of any treaty obligation binding upon the government of the Philippines is
anchored on the constitutional provision that the Philippines "adopts the generally
accepted principles of international law as part of the law of the land[.]" 76Pacta sunt
servanda is a fundamental international law principle that requires agreeing parties to
comply with their treaty obligations in good faith.77

Hence, the application of the provisions of the National Internal Revenue Code must be
subject to the provisions of tax treaties entered into by the Philippines with foreign
countries.

In Deutsche Bank AG Manila Branch v. Commissioner of Internal Revenue, 78 this court

stressed the binding effects of tax treaties. It dealt with the issue of "whether the
failure to strictly comply with [Revenue Memorandum Order] RMO No. 1-200079 will
deprive persons or corporations of the benefit of a tax treaty."80 Upholding the tax
treaty over the administrative issuance, this court reasoned thus: chanRoblesvirtualLawlibrary

Our Constitution provides for adherence to the general principles of international law
as  part of the law of the land. The time-honored international principle of pacta sunt
servanda demands the performance in good faith of treaty obligations on the part of
the states that enter into the agreement. Every treaty in force is binding upon the
parties, and obligations under the treaty must be performed by them in good faith.
More importantly,  treaties have the force and effect of law in this jurisdiction.

Tax treaties are entered into "to reconcile the national fiscal legislations of the
contracting parties and, in turn, help the taxpayer avoid simultaneous taxations in two
different jurisdictions."  CIR v. S.C. Johnson and Son, Inc. further clarifies that "tax
conventions are drafted with a view towards the elimination of international juridical
double taxation, which is defined as the imposition of comparable taxes in two or more
states on the same taxpayer in respect of the same subject matter and for identical
periods. The apparent rationale for doing away with double taxation is to encourage the
free flow of goods and services and the movement of capital, technology and persons
between countries, conditions deemed vital in creating robust and dynamic economies.
Foreign investments will only thrive in a fairly predictable and reasonable international
investment climate and the protection against double taxation is crucial in creating such
a climate." Simply put, tax treaties are entered into to minimize, if not eliminate the
harshness of international juridical double taxation, which is why they are also known
as double tax treaty or double tax agreements.

"A state that has contracted valid international obligations is bound to make in its
legislations those modifications that may be necessary to ensure the fulfillment of the
obligations undertaken. " Thus, laws and issuances must ensure that the reliefs granted
under tax treaties are accorded to the parties entitled thereto. The BIR must not
impose additional requirements that would negate the availment of the reliefs provided
for under international agreements. More so, when the RP-Germany Tax Treaty does
not provide for any pre-requisite for the availment of the benefits under said
agreement.
....

Bearing in mind the rationale of tax treaties, the period of application for the availment
of tax treaty relief as required by RMO No. 1 -2000 should not operate to divest
entitlement to the relief as it would constitute a violation of the duty required by good
faith in complying with a tax treaty. The denial of the availment of tax relief for the
failure of a taxpayer to apply within the prescribed period under the administrative
issuance would impair the value of the tax treaty. At most, the application for a tax
treaty relief from the BIR should merely operate to confirm the entitlement of the
taxpayer to the relief.

The obligation to comply with a tax treaty must take precedence over the objective of
RMO No. 1-2000. Logically, noncompliance with tax treaties has negative implications
on international relations, and unduly discourages foreign investors. While the
consequences sought to be prevented by RMO No. 1-2000 involve an administrative
procedure, these may be remedied through other system management processes, e.g.,
the imposition of a fine or penalty. But we cannot totally deprive those who are entitled
to the benefit of a treaty for failure to strictly comply with an administrative issuance
requiring prior application for tax treaty relief.81 (Emphasis supplied, citations omitted)
cralawlawlibrary

On March 11, 1976, the representatives82 for the government of the Republic of the
Philippines and for the government of Canada signed the Convention between the
Philippines and Canada for the Avoidance of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on Income (Republic of the Philippines-Canada Tax
Treaty). This treaty entered into force on December 21, 1977.

Article V83 of the Republic of the Philippines-Canada Tax Treaty defines "permanent
establishment" as a "fixed place of business in which the business of the enterprise is
wholly or partly carried on."84

Even though there is no fixed place of business, an enterprise of a Contracting State is

deemed to have a permanent establishment in the other Contracting State if under
certain conditions there is a person acting for it.

Specifically, Article V(4) of the Republic of the Philippines-Canada Tax Treaty states
that "[a] person acting in a Contracting State on behalf of an enterprise of the other
Contracting State (other than an agent of independent status to whom paragraph 6
applies) shall be deemed to be a permanent establishment in the first-mentioned State
if . . . he has and habitually exercises in that State an authority to conclude contracts
on behalf of the enterprise, unless his activities are limited to the purchase of goods or
merchandise for that enterprise[.]" The provision seems to refer to one who would be
considered an agent under Article 186883 of the Civil Code of the Philippines.

On the other hand, Article V(6) provides that "[a]n enterprise of a Contracting State
shall not be deemed to have a permanent establishment in the other Contracting State
merely because it carries on business in that other State through a broker, general
commission agent or any other agent of an independent status, where such
persons are acting in the ordinary course of their business."

Considering Article XV86 of the same Treaty, which covers dependent personal services,
the term "dependent" would imply a relationship between the principal and the agent
that is akin to an employer-employee relationship.

Thus, an agent may be considered to be dependent on the principal where the latter
exercises comprehensive control and detailed instructions over the means and results
of the activities of the agent.87

Section 3 of Republic Act No. 776, as amended, also known as The Civil Aeronautics Act
of the Philippines, defines a general sales agent as "a person, not a bonafide employee
of an air carrier, who pursuant to an authority from an airline, by itself or through an
agent, sells or offers for sale any air transportation, or negotiates for, or holds himself
out by solicitation, advertisement or otherwise as one who sells, provides, furnishes,
contracts or arranges for, such air transportation."88 General sales agents and their
property, property rights, equipment, facilities, and franchise are subject to the
regulation and control of the Civil Aeronautics Board.89 A permit or authorization issued
by the Civil Aeronautics Board is required before a general sales agent may engage in
such an activity.90

Through the appointment of Aerotel as its local sales agent, petitioner is deemed to
have created a "permanent"establishment" in the Philippines as defined under the
Republic of the Philippines-Canada Tax Treaty.

Petitioner appointed Aerotel as its passenger general sales agent to perform the sale of
transportation on petitioner and handle reservations, appointment, and supervision of
International Air Transport Association-approved and petitioner-approved sales agents,
including the following services: chanRoblesvirtualLawlibrary

ARTICLE 7
GSA SERVICES

The GSA [Aerotel Ltd., Corp.] shall perform on behalf of AC [Air Canada] the following
services:chanRoblesvirtualLawlibrary

a) Be the fiduciary of AC and in such capacity act solely and entirely for the benefit of
AC in every matter relating to this Agreement;
....

c) Promotion of passenger transportation on AC;

....

e) Without the need for endorsement by AC, arrange for the reissuance, in the Territory
of the GSA [Philippines], of traffic documents issued by AC outside the said territory of
the GSA [Philippines], as required by the passenger(s);
....

h) Distribution among passenger sales agents and display of timetables, fare sheets,
tariffs and publicity material provided by AC in accordance with the reasonable
requirements of AC;
....

j) Distribution of official press releases provided by AC to media and reference of any

press or public relations inquiries to AC;
....

o) Submission for AC's approval, of an annual written sales plan on or before a date to
be determined by AC and in a form acceptable to AC;
....

q) Submission of proposals for AC's approval of passenger sales agent incentive plans
at a reasonable time in advance of proposed implementation.
....

r) Provision of assistance on request, in its relations with Governmental and other

authorities, offices and agencies in the Territory [Philippines].
....

u) Follow AC guidelines for the handling of baggage claims and customer complaints
and, unless otherwise stated in the guidelines, refer all such claims and complaints to
AC.91cralawlawlibrary

Under the terms of the Passenger General Sales Agency Agreement, Aerotel will
"provide at its own expense and acceptable to [petitioner Air Canada], adequate and
suitable premises, qualified staff, equipment, documentation, facilities and supervision
and in consideration of the remuneration and expenses payable[,] [will] defray all costs
and expenses of and incidental to the Agency."92 "[I]t is the sole employer of its
employees and . . . is responsible for [their] actions ... or those of any
subcontractor."93 In remuneration for its services, Aerotel would be paid by petitioner a
commission on sales of transportation plus override commission on flown
revenues.94 Aerotel would also be reimbursed "for all authorized expenses supported by
original supplier invoices."95

Aerotel is required to keep "separate books and records of account, including

supporting documents, regarding all transactions at, through or in any way connected
with [petitioner Air Canada] business."96

"If representing more than one carrier, [Aerotel must] represent all carriers in an
unbiased way."97 Aerotel cannot "accept additional appointments as General Sales
Agent of any other carrier without the prior written consent of [petitioner Air
Canada]."98

The Passenger General Sales Agency Agreement "may be terminated by either party
without cause upon [no] less than 60 days' prior notice in writing[.]"99 In case of breach
of any provisions of the Agreement, petitioner may require Aerotel "to cure the breach
in 30 days failing which [petitioner Air Canada] may terminate [the] Agreement[.]"100

The following terms are indicative of Aerotel's dependent status: chanRoblesvirtualLawlibrary

First, Aerotel must give petitioner written notice "within 7 days of the date [it] acquires
or takes control of another entity or merges with or is acquired or controlled by another
person or entity[,]"101 Except with the written consent of petitioner, Aerotel must not
acquire a substantial interest in the ownership, management, or profits of a passenger
sales agent affiliated with the International Air Transport Association or a non-affiliated
passenger sales agent nor shall an affiliated passenger sales agent acquire a substantial
interest in Aerotel as to influence its commercial policy and/or management
decisions.102 Aerotel must also provide petitioner "with a report on any interests held by
[it], its owners, directors, officers, employees and their immediate families in
companies and other entities in the aviation industry or ... industries related to
it[.]"103 Petitioner may require that any interest be divested within a set period of
time.104

Second, in carrying out the services, Aerotei cannot enter into any contract on behalf of
petitioner without the express written consent of the latter;105 it must act according to
the standards required by petitioner;106 "follow the terms and provisions of the
[petitioner Air Canada] GS A Manual [and all] written instructions of [petitioner Air
Canada;]"107 and "[i]n the absence of an applicable provision in the Manual or
instructions, [Aerotei must] carry out its functions in accordance with [its own]
standard practices and procedures[.]"108

Third, Aerotei must only "issue traffic documents approved by [petitioner Air Canada]
for all transportation over [its] services[.]"109 All use of petitioner's name, logo, and
marks must be with the written consent of petitioner and according to petitioner's
corporate standards and guidelines set out in the Manual.110

Fourth, all claims, liabilities, fines, and expenses arising from or in connection with the
transportation sold by Aerotei are for the account of petitioner, except in the case of
negligence of Aerotei.111

Aerotei is a dependent agent of petitioner pursuant to the terms of the Passenger

General Sales Agency Agreement executed between the parties. It has the authority or
power to conclude contracts or bind petitioner to contracts entered into in the
Philippines. A third-party liability on contracts of Aerotei is to petitioner as the principal,
and not to Aerotei, and liability to such third party is enforceable against petitioner.
While Aerotei maintains a certain independence and its activities may not be devoted
wholly to petitioner, nonetheless, when representing petitioner pursuant to the
Agreement, it must carry out its functions solely for the benefit of petitioner and
according to the latter's Manual and written instructions. Aerotei is required to submit
its annual sales plan for petitioner's approval.

In essence, Aerotei extends to the Philippines the transportation business of petitioner.

It is a conduit or outlet through which petitioner's airline tickets are sold.112

Under Article VII (Business Profits) of the Republic of the Philippines-Canada Tax
Treaty, the "business profits" of an enterprise of a Contracting State is "taxable only in
that State[,] unless the enterprise carries on business in the other Contracting State
through a permanent establishment);.]"113 Thus, income attributable to Aerotel or from
business activities effected by petitioner through Aerotel may be taxed in the
Philippines. However, pursuant to the last paragraph114 of Article VII in relation to
Article VIII115 (Shipping and Air Transport) of the same Treaty, the tax imposed on
income derived from the operation of ships or aircraft in international traffic should not
exceed 1 1/2% of gross revenues derived from Philippine sources.

IV

While petitioner is taxable as a resident foreign corporation under Section 28(A)(1) of

the 1997 National Internal Revenue Code on its taxable income116 from sale of airline
tickets in the Philippines, it could only be taxed at a maximum of 1 1/2% of gross
revenues, pursuant to Article VIII of the Republic of the Philippines-Canada Tax Treaty
that applies to petitioner as a "foreign corporation organized and existing under the
laws of Canada[.]"117

Tax treaties form part of the law of the land,118 and jurisprudence has applied the
statutory construction principle that specific laws prevail over general ones.119

The Republic of the Philippines-Canada Tax Treaty was ratified on December 21, 1977
and became valid and effective on that date. On the other hand, the applicable
provisions120 relating to the taxability of resident foreign corporations and the rate of
such tax found in the National Internal Revenue Code became effective on January 1,
1998.121 Ordinarily, the later provision governs over the earlier one.122 In this case,
however, the provisions of the Republic of the Philippines-Canada Tax Treaty are more
specific than the provisions found in the National Internal Revenue Code.

These rules of interpretation apply even though one of the sources is a treaty and not
simply a statute.

Article VII, Section 21 of the Constitution provides: chanRoblesvirtualLawlibrary

SECTION 21. No treaty or international agreement shall be valid and effective unless
concurred in by at least two-thirds of all the Members of the Senate. cralawlawlibrary

This provision states the second of two ways through which international obligations
become binding. Article II, Section 2 of the Constitution deals with international
obligations that are incorporated, while Article VII, Section 21 deals with international
obligations that become binding through ratification.

"Valid and effective" means that treaty provisions that define rights and duties as well
as definite prestations have effects equivalent to a statute. Thus, these specific treaty
provisions may amend statutory provisions. Statutory provisions may also amend these
types of treaty obligations.

We only deal here with bilateral treaty state obligations that are not international
obligations erga omnes. We are also not required to rule in this case on the effect of
international customary norms especially those with jus cogens character.

The second paragraph of Article VIII states that "profits from sources within a
Contracting State derived by an enterprise of the other Contracting State from the
operation of ships or aircraft in international traffic may be taxed in the first-mentioned
State but the tax so charged shall not exceed the lesser of a) one and one-half per cent
of the gross revenues derived from sources in that State; and b) the lowest rate of
Philippine tax imposed on such profits derived by an enterprise of a third State."

The Agreement between the government of the Republic of the Philippines and the
government of Canada on Air Transport, entered into on January 14, 1997, reiterates
the effectivity of Article VIII of the Republic of the Philippines-Canada Tax Treaty:chanRoblesvirtualLawlibrary

ARTICLE XVI
(Taxation)

The Contracting Parties shall act in accordance with the provisions of Article VIII of the
Convention between the Philippines and Canada for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed at Manila
on March 31, 1976 and entered into force on December 21, 1977, and any
amendments thereto, in respect of the operation of aircraft in international traffic.123 cralawlawlibrary

Petitioner's income from sale of ticket for international carriage of passenger is income
derived from international operation of aircraft. The sale of tickets is closely related to
the international operation of aircraft that it is considered incidental thereto.

"[B]y reason of our bilateral negotiations with [Canada], we have agreed to have our
right to tax limited to a certain extent[.]"124 Thus, we are bound to extend to a
Canadian air carrier doing business in the Philippines through a local sales agent the
benefit of a lower tax equivalent to 1 1/2% on business profits derived from sale of
international air transportation.

Finally, we reject petitioner's contention that the Court of Tax Appeals erred in denying
its claim for refund of erroneously paid Gross Philippine Billings tax on the ground that
it is subject to income tax under Section 28(A)(1) of the National Internal Revenue
Code because (a) it has not been assessed at all by the Bureau of Internal Revenue for
any income tax liability;125 and (b) internal revenue taxes cannot be the subject of set-
off or compensation,126 citing Republic v. Mambulao Lumber Co., et al.127 and Francia v.
Intermediate Appellate Court.128

In SMI-ED Philippines Technology, Inc. v. Commissioner of Internal Revenue,129 we

have ruled that "[i]n an action for the refund of taxes allegedly erroneously paid, the
Court of Tax Appeals may determine whether there are taxes that should have been
paid in lieu of the taxes paid."130 The determination of the proper category of tax that
should have been paid is incidental and necessary to resolve the issue of whether a
refund should be granted.131 Thus: chanRoblesvirtualLawlibrary

Petitioner argued that the Court of Tax Appeals had no jurisdiction to subject it to 6%
capital gains tax or other taxes at the first instance. The Court of Tax Appeals has no
power to make an assessment.

As earlier established, the Court of Tax Appeals has no assessment powers. In stating
that petitioner's transactions are subject to capital gains tax, however, the Court of Tax
Appeals was not making an assessment. It was merely determining the proper category
of tax that petitioner should have paid, in view of its claim that it erroneously imposed
upon itself and paid the 5% final tax imposed upon PEZA-registered enterprises.

The determination of the proper category of tax that petitioner should have paid is an
incidental matter necessary for the resolution of the principal issue, which is whether
petitioner was entitled to a refund.

The issue of petitioner's claim for tax refund is intertwined with the issue of the proper
taxes that are due from petitioner. A claim for tax refund carries the assumption that
the tax returns filed were correct. If the tax return filed was not proper, the correctness
of the amount paid and, therefore, the claim for refund become questionable. In that
case, the court must determine if a taxpayer claiming refund of erroneously paid taxes
is more properly liable for taxes other than that paid.

In South African Airways v. Commissioner of Internal Revenue, South African Airways

claimed for refund of its erroneously paid 2 1/2% taxes on its gross Philippine billings.
This court did not immediately grant South African's claim for refund. This is because
although this court found that South African Airways was not subject to the 2 1/2% tax
on its gross Philippine billings, this court also found that it was subject to 32% tax on
its taxable income.

In this case, petitioner's claim that it erroneously paid the 5% final tax is an admission
that the quarterly tax return it filed in 2000 was improper. Hence, to determine if
petitioner was entitled to the refund being claimed, the Court of Tax Appeals has the
duty to determine if petitioner was indeed not liable for the 5% final tax and, instead,
liable for taxes other than the 5% final tax. As in South African Airways,  petitioner's
request for refund can neither be granted nor denied outright without such
determination.

If the taxpayer is found liable for taxes other than the erroneously paid 5% final tax,
the amount of the taxpayer's liability should be computed and deducted from the
refundable amount.

Any liability in excess of the refundable amount, however, may not be collected in a
case involving solely the issue of the taxpayer's entitlement to refund. The question of
tax deficiency is distinct and unrelated to the question of petitioner's entitlement to
refund. Tax deficiencies should be subject to assessment procedures and the rules of
prescription. The court cannot be expected to perform the BIR's duties whenever it fails
to do so either through neglect or oversight. Neither can court processes be used as a
tool to circumvent laws protecting the rights of taxpayers.132 cralawlawlibrary

Hence, the Court of Tax Appeals properly denied petitioner's claim for refund of
allegedly erroneously paid tax on its Gross Philippine Billings, on the ground that it was
liable instead for the regular 32% tax on its taxable income received from sources
within the Philippines. Its determination of petitioner's liability for the 32% regular
income tax was made merely for the purpose of ascertaining petitioner's entitlement to
a tax refund and not for imposing any deficiency tax.

In this regard, the matter of set-off raised by petitioner is not an issue. Besides, the
cases cited are based on different circumstances. In both cited cases,133 the taxpayer
claimed that his (its) tax liability was off-set by his (its) claim against the government.

Specifically, in Republic v. Mambulao Lumber Co., et al, Mambulao Lumber contended

that the amounts it paid to the government as reforestation charges from 1947 to
1956, not having been used in the reforestation of the area covered by its license, may
be set off or applied to the payment of forest charges still due and owing from
it.134 Rejecting Mambulao's claim of legal compensation, this court ruled: chanRoblesvirtualLawlibrary

[A]ppellant and appellee are not mutually creditors and debtors of each other.
Consequently, the law on compensation is inapplicable. On this point, the trial court
correctly observed: chanRoblesvirtualLawlibrary

Under Article 1278, NCC, compensation should take place when two persons in their
own right are creditors and debtors of each other. With respect to the forest charges
which the defendant Mambulao Lumber Company has paid to the government, they are
in the coffers of the government as taxes collected, and the government does not owe
anything to defendant Mambulao Lumber Company. So, it is crystal clear that the
Republic of the Philippines and the Mambulao Lumber Company are not creditors and
debtors of each other, because compensation refers to mutual debts. * * *. cralawlawlibrary

And the weight of authority is to the effect that internal revenue taxes, such as the
forest charges in question, can not be the subject of set-off or compensation.

A claim for taxes is not such a debt, demand, contract or judgment as is allowed to be
set-off under the statutes of set-off, which are construed uniformly, in the light of
public policy, to exclude the remedy in an action or any indebtedness of the state or
municipality to one who is liable to the state or municipality for taxes. Neither are they
a proper subject of recoupment since they do not arise out of the contract or
transaction sued on. * * *. (80 C.J.S. 73-74.)
The general rule, based on grounds of public policy is well-settled that no set-off is
admissible against demands for taxes levied for general or local governmental
purposes. The reason on which the general rule is based, is that taxes are not in the
nature of contracts between the party and party but grow out of a duty to, and are the
positive acts of the government, to the making and enforcing of which, the personal
consent of individual taxpayers is not required. * * * If the taxpayer can properly
refuse to pay his tax when called upon by the Collector, because he has a claim against
the governmental body which is not included in the tax levy, it is plain that some
legitimate and necessary expenditure must be curtailed. If the taxpayer's claim is
disputed, the collection of the tax must await and abide the result of a lawsuit, and
meanwhile the financial affairs of the government will be thrown into great confusion.
(47 Am. Jur. 766-767.)135 (Emphasis supplied)
cralawlawlibrary

In Francia, this court did not allow legal compensation since not all requisites of legal
compensation provided under Article 1279 were present.136 In that case, a portion of
Francia's property in Pasay was expropriated by the national government,137 which did
not immediately pay Francia. In the meantime, he failed to pay the real property tax
due on his remaining property to the local government of Pasay, which later on would
auction the property on account of such delinquency. He then moved to set aside the
auction sale and argued, among others, that his real property tax delinquency was
extinguished by legal compensation on account of his unpaid claim against the national
government.139 This court ruled against Francia: chanRoblesvirtualLawlibrary

There is no legal basis for the contention. By legal compensation, obligations of

persons, who in their own right are reciprocally debtors and creditors of each other, are
extinguished (Art. 1278, Civil Code). The circumstances of the case do not satisfy the
requirements provided by Article 1279, to wit: chanRoblesvirtualLawlibrary

(1) that each one of the obligors be bound principally and that he be at the same time a
principal creditor of the other;

cralawlawlibrary
xxx     xxx     xxx

(3) that the two debts be due.

xxx     xxx     xxx

This principal contention of the petitioner has no merit. We have consistently ruled that
there can be no off-setting of taxes against the claims that the taxpayer may have
against the government. A person cannot refuse to pay a tax on the ground that the
government owes him an amount equal to or greater than the tax being collected. The
collection of a tax cannot await the results of a lawsuit against the government.
....

There are other factors which compel us to rule against the petitioner. The tax was due
to the city government while the expropriation was effected by the national
government. Moreover, the amount of P4,116.00 paid by the national government for
the 125 square meter portion of his lot was deposited with the Philippine National Bank
long before the sale at public auction of his remaining property. Notice of the deposit
dated September 28, 1977 was received by the petitioner on September 30, 1977. The
petitioner admitted in his testimony that he knew about the P4,116.00 deposited with
the bank but he did not withdraw it. It would have been an easy matter to withdraw
P2,400.00 from the deposit so that he could pay the tax obligation thus aborting the
sale at public auction.140 cralawlawlibrary

The ruling in Francia was applied to the subsequent cases of Caltex Philippines, Inc. v.
Commission on Audit141 and Philex Mining Corporation v. Commissioner of Internal
Revenue.142 In Caltex, this court reiterated: chanRoblesvirtualLawlibrary

[A] taxpayer may not offset taxes due from the claims that he may have against the
government. Taxes cannot be the subject of compensation because the government
and taxpayer are not mutually creditors and debtors of each other and a claim for taxes
is not such a debt, demand, contract or judgment as is allowed to beset-
off.143 (Citations omitted) cralawlawlibrary

Philex Mining ruled that "[t]here is a material distinction between a tax and debt. Debts
are due to the Government in its corporate capacity, while taxes are due to the
Government in its sovereign capacity."144 Rejecting Philex Mining's assertion that the
imposition of surcharge and interest was unjustified because it had no obligation to pay
the excise tax liabilities within the prescribed period since, after all, it still had pending
claims for VAT input credit/refund with the Bureau of Internal Revenue, this court
explained: chanRoblesvirtualLawlibrary

To be sure, we cannot allow Philex to refuse the payment of its tax liabilities on the
ground that it has a pending tax claim for refund or credit against the government
which has not yet been granted. It must be noted that a distinguishing feature of a tax
is that it is compulsory rather than a matter of bargain. Hence, a tax does not depend
upon the consent of the taxpayer. If any tax payer can defer the payment of taxes by
raising the defense that it still has a pending claim for refund or credit, this would
adversely affect the government revenue system. A taxpayer cannot refuse to pay his
taxes when they fall due simply because he has a claim against the government or that
the collection of the tax is contingent on the result of the lawsuit it filed against the
government. Moreover, Philex's theory that would automatically apply its VAT input
credit/refund against its tax liabilities can easily give rise to confusion and abuse,
depriving the government of authority over the manner by which taxpayers credit and
offset their tax liabilities.145 (Citations omitted)
cralawlawlibrary

In sum, the rulings in those cases were to the effect that the taxpayer cannot simply
refuse to pay tax on the ground that the tax liabilities were off-set against any alleged
claim the taxpayer may have against the government. Such would merely be in keeping
with the basic policy on prompt collection of taxes as the lifeblood of the government.
Here, what is involved is a denial of a taxpayer's refund claim on account of the Court
of Tax Appeals' finding of its liability for another tax in lieu of the Gross Philippine
Billings tax that was allegedly erroneously paid.

Squarely applicable is South African Airways where this court rejected similar

arguments on the denial of claim for tax refund: chanRoblesvirtualLawlibrary

Commissioner of Internal Revenue v. Court of Tax Appeals, however, granted the

offsetting of a tax refund with a tax deficiency in this wise: chanRoblesvirtualLawlibrary

Further, it is also worth noting that the Court of Tax Appeals erred in denying
petitioner's supplemental motion for reconsideration alleging bringing to said court's
attention the existence of the deficiency income and business tax assessment against
Citytrust. The fact of such deficiency assessment is intimately related to and
inextricably intertwined with the right of respondent bank to claim for a tax refund for
the same year. To award such refund despite the existence of that deficiency
assessment is an absurdity and a polarity in conceptual effects. Herein private
respondent cannot be entitled to refund and at the same time be liable for a tax
deficiency assessment for the same year.

The grant of a refund is founded on the assumption that the tax return is valid, that is,
the facts stated therein are true and correct. The deficiency assessment, although not
yet final, created a doubt as to and constitutes a challenge against the truth and
accuracy of the facts stated in said return which, by itself and without unquestionable
evidence, cannot be the basis for the grant of the refund.

Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the
applicable law when the claim of Citytrust was filed, provides that "(w)hen an
assessment is made in case of any list, statement, or return, which in the opinion of the
Commissioner of Internal Revenue was false or fraudulent or contained any
understatement or undervaluation, no tax collected under such assessment shall be
recovered by any suits unless it is proved that the said list, statement, or return was
not false nor fraudulent and did not contain any understatement or undervaluation; but
this provision shall not apply to statements or returns made or to be made in good faith
regarding annual depreciation of oil or gas wells and mines."

Moreover, to grant the refund without determination of the proper assessment and the
tax due would inevitably result in multiplicity of proceedings or suits. If the deficiency
assessment should subsequently be upheld, the Government will be forced to institute
anew a proceeding for the recovery of erroneously refunded taxes which recourse must
be filed within the prescriptive period of ten years after discovery of the falsity, fraud or
omission in the false or fraudulent return involved. This would necessarily require and
entail additional efforts and expenses on the part of the Government, impose a burden
on and a drain of government funds, and impede or delay the collection of much-
needed revenue for governmental operations.

Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both

logically necessary and legally appropriate that the issue of the deficiency tax
assessment against Citytrust be resolved jointly with its claim for tax refund, to
determine once and for all in a single proceeding the true and correct amount of tax
due or refundable.

In fact, as the Court of Tax Appeals itself has heretofore conceded, it would be only just
and fair that the taxpayer and the Government alike be given equal opportunities to
avail of remedies under the law to defeat each other's claim and to determine all
matters of dispute between them in one single case. It is important to note that in
determining whether or not petitioner is entitled to the refund of the amount paid, it
would [be] necessary to determine how much the Government is entitled to collect as
taxes. This would necessarily include the determination of the correct liability of the
taxpayer and, certainly, a determination of this case would constitute res judicata on
both parties as to all the matters subject thereof or necessarily involved therein.
cralawlawlibrary

Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997 NIRC.
The above pronouncements are, therefore, still applicable today.

Here, petitioner's similar tax refund claim assumes that the tax return that it filed was
correct. Given, however, the finding of the CTA that petitioner, although not liable
under Sec. 28(A)(3)(a) of the 1997 NIRC, is liable under Sec. 28(A)(1), the correctness
of the return filed by petitioner is now put in doubt. As such, we cannot grant the
prayer for a refund.146 (Emphasis supplied, citation omitted)cralawlawlibrary

In the subsequent case of United Airlines, Inc. v. Commissioner of Internal

Revenue,147 this court upheld the denial of the claim for refund based on the Court of
Tax Appeals' finding that the taxpayer had, through erroneous deductions on its gross
income, underpaid its Gross Philippine Billing tax on cargo revenues for 1999, and the
amount of underpayment was even greater than the refund sought for erroneously paid
Gross Philippine Billings tax on passenger revenues for the same taxable period.148

In this case, the P5,185,676.77 Gross Philippine Billings tax paid by petitioner was
computed at the rate of 1 1/2% of its gross revenues amounting to
P345,711,806.08149 from the third quarter of 2000 to the second quarter of 2002. It is
quite apparent that the tax imposable under Section 28(A)(1) of the 1997 National
Internal Revenue Code [32% of taxable income, that is, gross income less deductions]
will exceed the maximum ceiling of 1 1/2% of gross revenues as decreed in Article VIII
of the Republic of the Philippines-Canada Tax Treaty. Hence, no refund is forthcoming.

WHEREFORE, the Petition is DENIED. The Decision dated August 26, 2005 and
Resolution dated April 8, 2005 of the Court of Tax Appeals En Banc are AFFIRMED.
 June 30, 1987

G.R. No. L-53961

NATIONAL DEVELOPMENT COMPANY, petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, respondent.

CRUZ, J.:

We are asked to reverse the decision of the Court of Tax Appeals on the ground that it is erroneous.
We have carefully studied it and find it is not; on the contrary, it is supported by law and doctrine. So
finding, we affirm.

Reduced to simplest terms, the background facts are as follows.

The national Development Company entered into contracts in Tokyo with several Japanese
shipbuilding companies for the construction of twelve ocean-going vessels.   The purchase price was
1

to come from the proceeds of bonds issued by the Central Bank.   Initial payments were made in
2

cash and through irrevocable letters of credit.   Fourteen promissory notes were signed for the
3

balance by the NDC and, as required by the shipbuilders, guaranteed by the Republic of the
Philippines.   Pursuant thereto, the remaining payments and the interests thereon were remitted in
4

due time by the NDC to Tokyo. The vessels were eventually completed and delivered to the NDC in
Tokyo. 5
The NDC remitted to the shipbuilders in Tokyo the total amount of US$4,066,580.70 as interest on
the balance of the purchase price. No tax was withheld. The Commissioner then held the NDC liable
on such tax in the total sum of P5,115,234.74. Negotiations followed but failed. The BIR thereupon
served on the NDC a warrant of distraint and levy to enforce collection of the claimed amount.   The
6

NDC went to the Court of Tax Appeals.

The BIR was sustained by the CTA except for a slight reduction of the tax deficiency in the sum of
P900.00, representing the compromise penalty.   The NDC then came to this Court in a petition
7

for certiorari.

The petition must fail for the following reasons.

The Japanese shipbuilders were liable to tax on the interest remitted to them under Section 37 of the
Tax Code, thus:

SEC. 37. Income from sources within the Philippines. — (a) Gross income from sources
within the Philippines. — The following items of gross income shall be treated as gross
income from sources within the Philippines:

(1) Interest. — Interest derived from sources within the Philippines, and interest on bonds,
notes, or other interest-bearing obligations of residents, corporate or otherwise;

x x x           x x x          x x x

The petitioner argues that the Japanese shipbuilders were not subject to tax under the above
provision because all the related activities — the signing of the contract, the construction of the
vessels, the payment of the stipulated price, and their delivery to the NDC — were done in
Tokyo.   The law, however, does not speak of activity but of "source," which in this case is the NDC.
8

This is a domestic and resident corporation with principal offices in Manila.

As the Tax Court put it:

It is quite apparent, under the terms of the law, that the Government's right to levy and
collect income tax on interest received by foreign corporations not engaged in trade or
business within the Philippines is not planted upon the condition that 'the activity or labor —
and the sale from which the (interest) income flowed had its situs' in the Philippines. The law
specifies: 'Interest derived from sources within the Philippines, and interest on bonds, notes,
or other interest-bearing obligations of residents, corporate or otherwise.' Nothing there
speaks of the 'act or activity' of non-resident corporations in the Philippines, or place where
the contract is signed. The residence of the obligor who pays the interest rather than the
physical location of the securities, bonds or notes or the place of payment, is the determining
factor of the source of interest income. (Mertens, Law of Federal Income Taxation, Vol. 8, p.
128, citing A.C. Monk & Co. Inc. 10 T.C. 77; Sumitomo Bank, Ltd., 19 BTA 480; Estate of
L.E. Mckinnon, 6 BTA 412; Standard Marine Ins. Co., Ltd., 4 BTA 853; Marine Ins. Co., Ltd.,
4 BTA 867.) Accordingly, if the obligor is a resident of the Philippines the interest payment
paid by him can have no other source than within the Philippines. The interest is paid not by
the bond, note or other interest-bearing obligations, but by the obligor. (See mertens,
Id., Vol. 8, p. 124.)

Here in the case at bar, petitioner National Development Company, a corporation duly
organized and existing under the laws of the Republic of the Philippines, with address and
 principal office at Calle Pureza, Sta. Mesa, Manila, Philippines unconditionally promised to
pay the Japanese shipbuilders, as obligor in fourteen (14) promissory notes for each vessel,
the balance of the contract price of the twelve (12) ocean-going vessels purchased and
acquired by it from the Japanese corporations, including the interest on the principal sum at
the rate of five per cent (5%) per annum. (See Exhs. "D", D-1" to "D-13", pp. 100-113, CTA
Records; par. 11, Partial Stipulation of Facts.) And pursuant to the terms and conditions of
these promisory notes, which are duly signed by its Vice Chairman and General Manager,
petitioner remitted to the Japanese shipbuilders in Japan during the years 1960, 1961, and
1962 the sum of $830,613.17, $1,654,936.52 and $1,541.031.00, respectively, as interest on
the unpaid balance of the purchase price of the aforesaid vessels. (pars. 13, 14, & 15, Partial
Stipulation of Facts.)

The law is clear. Our plain duty is to apply it as written. The residence of the obligor which
paid the interest under consideration, petitioner herein, is Calle Pureza, Sta. Mesa, Manila,
Philippines; and as a corporation duly organized and existing under the laws of the
Philippines, it is a domestic corporation, resident of the Philippines. (Sec. 84(c), National
Internal Revenue Code.) The interest paid by petitioner, which is admittedly a resident of the
Philippines, is on the promissory notes issued by it. Clearly, therefore, the interest remitted to
the Japanese shipbuilders in Japan in 1960, 1961 and 1962 on the unpaid balance of the
purchase price of the vessels acquired by petitioner is interest derived from sources within
the Philippines subject to income tax under the then Section 24(b)(1) of the National Internal
Revenue Code.  9

There is no basis for saying that the interest payments were obligations of the Republic of the
Philippines and that the promissory notes of the NDC were government securities exempt from
taxation under Section 29(b)[4] of the Tax Code, reading as follows:

SEC. 29. Gross Income. — xxxx xxx xxx xxx

(b) Exclusion from gross income. — The following items shall not be included in gross
income and shall be exempt from taxation under this Title:

x x x           x x x          x x x

(4) Interest on Government Securities. — Interest upon the obligations of the Government of
the Republic of the Philippines or any political subdivision thereof, but in the case of such
obligations issued after approval of this Code, only to the extent provided in the act
authorizing the issue thereof. (As amended by Section 6, R.A. No. 82; emphasis supplied)

The law invoked by the petitioner as authorizing the issuance of securities is R.A. No. 1407, which in
fact is silent on this matter. C.A. No. 182 as amended by C.A. No. 311 does carry such authorization
but, like R.A. No. 1407, does not exempt from taxes the interests on such securities.

It is also incorrect to suggest that the Republic of the Philippines could not collect taxes on the
interest remitted because of the undertaking signed by the Secretary of Finance in each of the
promissory notes that:

Upon authority of the President of the Republic of the Philippines, the undersigned, for value
received, hereby absolutely and unconditionally guarantee (sic), on behalf of the Republic of
the Philippines, the due and punctual payment of both principal and interest of the above
note.10
There is nothing in the above undertaking exempting the interests from taxes. Petitioner has not
established a clear waiver therein of the right to tax interests. Tax exemptions cannot be merely
implied but must be categorically and unmistakably expressed.   Any doubt concerning this question
11

must be resolved in favor of the taxing power.  12

Nowhere in the said undertaking do we find any inhibition against the collection of the disputed
taxes. In fact, such undertaking was made by the government in consonance with and certainly not
against the following provisions of the Tax Code:

Sec. 53(b). Nonresident aliens. — All persons, corporations and general co-partnership

(companies colectivas), in whatever capacity acting, including lessees or mortgagors of real
or personal capacity, executors, administrators, receivers, conservators, fiduciaries,
employers, and all officers and employees of the Government of the Philippines having
control, receipt, custody; disposal or payment of interest, dividends, rents, salaries, wages,
premiums, annuities, compensations, remunerations, emoluments, or other fixed or
determinable annual or categorical gains, profits and income of any nonresident alien
individual, not engaged in trade or business within the Philippines and not having any office
or place of business therein, shall (except in the cases provided for in subsection (a) of this
section) deduct and withhold from such annual or periodical gains, profits and income a tax
to twenty (now 30%) per centum thereof: ...

Sec. 54. Payment of corporation income tax at source. — In the case of foreign corporations
subject to taxation under this Title not engaged in trade or business within the Philippines
and not having any office or place of business therein, there shall be deducted and withheld
at the source in the same manner and upon the same items as is provided in section fifty-
three a tax equal to thirty (now 35%) per centum thereof, and such tax shall be returned and
paid in the same manner and subject to the same conditions as provided in that section:....

Manifestly, the said undertaking of the Republic of the Philippines merely guaranteed the obligations
of the NDC but without diminution of its taxing power under existing laws.

In suggesting that the NDC is merely an administrator of the funds of the Republic of the Philippines,
the petitioner closes its eyes to the nature of this entity as a corporation. As such, it is governed in its
proprietary activities not only by its charter but also by the Corporation Code and other pertinent
laws.

The petitioner also forgets that it is not the NDC that is being taxed. The tax was due on the interests
earned by the Japanese shipbuilders. It was the income of these companies and not the Republic of
the Philippines that was subject to the tax the NDC did not withhold.

In effect, therefore, the imposition of the deficiency taxes on the NDC is a penalty for its failure to
withhold the same from the Japanese shipbuilders. Such liability is imposed by Section 53(c) of the
Tax Code, thus:

Section 53(c). Return and Payment. — Every person required to deduct and withhold any tax
under this section shall make return thereof, in duplicate, on or before the fifteenth day of
April of each year, and, on or before the time fixed by law for the payment of the tax, shall
pay the amount withheld to the officer of the Government of the Philippines authorized to
receive it. Every such person is made personally liable for such tax, and is indemnified
against the claims and demands of any person for the amount of any payments made in
accordance with the provisions of this section. (As amended by Section 9, R.A. No. 2343.)
In Philippine Guaranty Co. v. The Commissioner of Internal Revenue and the Court of Tax
Appeals,   the Court quoted with approval the following regulation of the BIR on the responsibilities
13

of withholding agents:

In case of doubt, a withholding agent may always protect himself by withholding the tax due,
and promptly causing a query to be addressed to the Commissioner of Internal Revenue for
the determination whether or not the income paid to an individual is not subject to
withholding. In case the Commissioner of Internal Revenue decides that the income paid to
an individual is not subject to withholding, the withholding agent may thereupon remit the
amount of a tax withheld. (2nd par., Sec. 200, Income Tax Regulations).

"Strict observance of said steps is required of a withholding agent before he could be released from
liability," so said Justice Jose P. Bengson, who wrote the decision. "Generally, the law frowns upon
exemption from taxation; hence, an exempting provision should be construed strictissimi juris."  14

The petitioner was remiss in the discharge of its obligation as the withholding agent of the
government an so should be held liable for its omission.

WHEREFORE, the appealed decision is AFFIRMED, without any pronouncement as to costs. It is so

ordered.