G.R. No.
L-17518             October 30, 1922 decision of the Supreme Court of the United States should not be followed in interpreting the statute in force
FREDERICK C. FISHER, plaintiff-appellant,
vs.
WENCESLAO TRINIDAD, Collector of Internal Revenue, defendant-appellee.
Fisher and De Witt and Antonio M. Opisso for appellants.
Acting Attorney-General Tuason for appellee.
JOHNSON, J.:
The only question presented by this appeal is: Are the "stock dividends" in the present case "income" and
taxable as such under the provisions of section 25 of Act No. 2833? While the appellant presents other
important questions, under the view which we have taken of the facts and the law applicable to the present
case, we deem it unnecessary to discuss them now.
The defendant demurred to the petition in the lower court. The facts are therefore admitted. They are simple
and may be stated as follows:
That during the year 1919 the Philippine American Drug Company was a corporation duly organized and
existing under the laws of the Philippine Islands, doing business in the City of Manila; that he appellant was a
stockholder in said corporation; that said corporation, as result of the business for that year, declared a "stock
dividend"; that the proportionate share of said stock divided of the appellant was P24,800; that the stock
dividend for that amount was issued to the appellant; that thereafter, in the month of March, 1920, the
appellant, upon demand of the appellee, paid under protest, and voluntarily, unto the appellee the sum of
P889.91 as income tax on said stock dividend. For the recovery of that sum (P889.91) the present action was
instituted. The defendant demurred to the petition upon the ground that it did not state facts sufficient to
constitute cause of action. The demurrer was sustained and the plaintiff appealed.
To sustain his appeal the appellant cites and relies on some decisions of the Supreme Court of the United
States as will as the decisions of the supreme court of some of the states of the Union, in which the questions
before us, based upon similar statutes, was discussed. Among the most important decisions may be
mentioned the following: Towne vs. Eisner, 245 U.S., 418; Doyle vs. Mitchell Bors. Co., 247 U.S., 179; Eisner
vs. Macomber, 252 U.S., 189; Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. Charlottesville
Woolen Mills, 93 Va., 673.
In each of said cases an effort was made to collect an "income tax" upon "stock dividends" and in each case it
was held that "stock dividends" were capital and not an "income" and therefore not subject to the "income tax"
law.
The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U.S., 189) that a "stock
dividend" is not "income" but argues that said Act No. 2833, in imposing the tax on the stock dividend, does
not violate the provisions of the Jones Law. The appellee further argues that the statute of the United States
providing for tax upon stock dividends is different from the statute of the Philippine Islands, and therefore the
here.
For the purpose of ascertaining the difference in the said statutes ( (United States and Philippine Islands),
providing for an income tax in the United States as well as that in the Philippine Islands, the two statutes are
here quoted for the purpose of determining the difference, if any, in the language of the two statutes.
Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the collection of an "income
tax." Section 2 of said Act attempts to define what is an income. The definition follows:
That the term "dividends" as used in this title shall be held to mean any distribution made or ordered
to made by a corporation, . . . which stock dividend shall be considered income, to the amount of its
cash value.
Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax." Section 25 of said Act
attempts to define the application of the income tax. The definition follows:
The term "dividends" as used in this Law shall be held to mean any distribution made or ordered to
be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen
hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the
corporation, . . . . Stock dividend shall be considered income, to the amount of the earnings or profits
distributed.
It will be noted from a reading of the provisions of the two laws above quoted that the writer of the law of the
Philippine Islands must have had before him the statute of the United States. No important argument can be
based upon the slight different in the wording of the two sections.
It is further argued by the appellee that there are no constitutional limitations upon the power of the Philippine
Legislature such as exist in the United States, and in support of that contention, he cites a number of
decisions. There is no question that the Philippine Legislature may provide for the payment of an income tax,
but it cannot, under the guise of an income tax, collect a tax on property which is not an "income." The
Philippine Legislature can not impose a tax upon "property" under a law which provides for a tax upon
"income" only. The Philippine Legislature has no power to provide a tax upon "automobiles" only, and under
that law collect a tax upon a carreton or bull cart. Constitutional limitations, that is to say, a statute expressly
adopted for one purpose cannot, without amendment, be applied to another purpose which is entirely distinct
and different. A statute providing for an income tax cannot be construed to cover property which is not, in fact
income. The Legislature cannot, by a statutory declaration, change the real nature of a tax which it imposes. A
law which imposes an important tax on rice only cannot be construed to an impose an importation tax on corn.
It is true that the statute in question provides for an income tax and contains a further provision that "stock
dividends" shall be considered income and are therefore subject to income tax provided for in said law. If
"stock dividends" are not "income" then the law permits a tax upon something not within the purpose and
intent of the law.
It becomes necessary in this connection to ascertain what is an "income in order that we may be able to
determine whether "stock dividends" are "income" in the sense that the word is used in the statute. Perhaps it
would be more logical to determine first what are "stock dividends" in order that we may more clearly
understand their relation to "income." Generally speaking, stock dividends represent undistributed increase in
the capital of corporations or firms, joint stock companies, etc., etc., for a particular period. They are used to
show the increased interest or proportional shares in the capital of each stockholder. In other words, the
inventory of the property of the corporation, etc., for particular period shows an increase in its capital, so that
the stock theretofore issued does not show the real value of the stockholder's interest, and additional stock is
issued showing the increase in the actual capital, or property, or assets of the corporation, etc.
To illustrate: A and B form a corporation with an authorized capital of P10,000 for the purpose of opening and
conducting a drug store, with assets of the value of P2,000, and each contributes P1,000. Their entire assets
are invested in drugs and put upon the shelves in their place of business. They commence business without a
cent in the treasury. Every dollar contributed is invested. Shares of stock to the amount of P1,000 are issued
to each of the incorporators, which represent the actual investment and entire assets of the corporation.
Business for the first year is good. Merchandise is sold, and purchased, to meet the demands of the growing
trade. At the end of the first year an inventory of the assets of the corporation is made, and it is then
ascertained that the assets or capital of the corporation on hand amount to P4,000, with no debts, and still not
a cent in the treasury. All of the receipts during the year have been reinvested in the business. Neither of the
stockholders have withdrawn a penny from the business during the year. Every peso received for the sale of
merchandise was immediately used in the purchase of new stock — new supplies. At the close of the year
there is not a centavo in the treasury, with which either A or B could buy a cup of coffee or a pair of shoes for
his family. At the beginning of the year they were P2,000, and at the end of the year they were P4,000, and
neither of the stockholders have received a centavo from the business during the year. At the close of the
year, when it is discovered that the assets are P4,000 and not P2,000, instead of selling the extra
merchandise on hand and thereby reducing the business to its original capital, they agree among themselves
to increase the capital they agree among themselves to increase the capital issued and for that purpose issue
additional stock in the form of "stock dividends" or additional stock of P1,000 each, which represents the
actual increase of the shares of interest in the business. At the beginning of the year each stockholder held
one-half interest in the capital. At the close of the year, and after the issue of the said stock dividends, they
each still have one-half interest in the business. The capital of the corporation increased during the year, but
has either of them received an income? It is not denied, for the purpose of ordinary taxation, that the taxable
property of the corporation at the beginning of the year was P2,000, that at the close of the year it
was P4,000, and that the tax rolls should be changed in accordance with the changed conditions in the
business. In other words, the ordinary tax should be increased by P2,000.
Another illustration: C and D organized a corporation for agricultural purposes with an authorized capital stock
of P20,000 each contributing P5,000. With that capital they purchased a farm and, with it, one hundred head
of cattle. Every peso contributed is invested. There is no money in the treasury. Much time and labor was
expanded during the year by the stockholders on the farm in the way of improvements. Neither received a
centavo during the year from the farm or the cattle. At the beginning of the year the assets of the corporation,
including the farm and the cattle, were P10,000, and at the close of the year and inventory of the property of
the corporation is made and it is then found that they have the same farm with its improvements and two
hundred head of cattle by natural increase. At the end of the year it is also discovered that, by reason of
business changes, the farm and the cattle both have increased in value, and that the value of the corporate
property is now P20,000 instead of P10,000 as it was at the beginning of the year. The incorporators instead
of reducing the property to its original capital, by selling off a part of its, issue to themselves "stock dividends"
to represent the proportional value or interest of each of the stockholders in the increased capital at the close
of the year. There is still not a centavo in the treasury and neither has withdrawn a peso from the business
during the year. No part of the farm or cattle has been sold and not a single peso was received out of the rents
or profits of the capital of the corporation by the stockholders.
Another illustration: A, an individual farmer, buys a farm with one hundred head of cattle for the sum of
P10,000. At the end of the first year, by reason of business conditions and the increase of the value of both
real estate and personal property, it is discovered that the value of the farm and the cattle is P20,000. A,
during the year, has received nothing from the farm or the cattle. His books at the beginning of the year show
that he had property of the value of P10,000. His books at the close of the year show that he has property of
the value of P20,000. A is not a corporation. The assets of his business are not shown therefore by certificates
of stock. His books, however, show that the value of his property has increased during the year by P10,000,
under any theory of business or law, be regarded as an "income" upon which the farmer can be required to
pay an income tax? Is there any difference in law in the condition of A in this illustration and the condition of A
and B in the immediately preceding illustration? Can the increase of the value of the property in either case be
regarded as an "income" and be subjected to the payment of the income tax under the law?
Each of the foregoing illustrations, it is asserted, is analogous to the case before us and, in view of that fact,
let us ascertain how lexicographers and the courts have defined an "income." The New Standard Dictionary,
edition of 1915, defines an income as "the amount of money coming to a person or corporation within a
specified time whether as payment or corporation within a specified time whether as payment for services,
interest, or profit from investment." Webster's International Dictionary defines an income as "the receipt,
salary; especially, the annual receipts of a private person or a corporation from property." Bouvier, in his law
dictionary, says that an "income" in the federal constitution and income tax act, is used in its common or
ordinary meaning and not in its technical, or economic sense. (146 Northwestern Reporter, 812) Mr. Black, in
his law dictionary, says "An income is the return in money  from one's business, labor, or capital invested;
gains, profit or private revenue." "An income tax is a tax on the yearly profits arising from property ,
professions, trades, and offices."
The Supreme Court of the United States, in the case o Gray vs. Darlington (82 U.S., 653), said in speaking of
income that mere advance in value in no sense constitutes the "income" specified in the revenue law as
"income" of the owner for the year in which the sale of the property was made. Such advance constitutes and
can be treated merely as an increase of capital. (In re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105
Pa., 414.)
Mr. Justice Hughes, later Associate Justice of the Supreme Court of the United States and now Secretary of
State of the United States, in his argument before the Supreme Court of the United States in the case of
Towne vs. Eisner, supra, defined an "income" in an income tax law, unless it is otherwise specified, to mean
cash or its equivalent. It does not mean choses in action or unrealized increments in the value of the property,
and cites in support of the definition, the definition given by the Supreme Court in the case of Gray vs.
Darlington, supra.
In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for the court, said: "Notwithstanding the
thoughtful discussion that the case received below, we cannot doubt that the dividend was capital as well for
the purposes of the Income Tax Law. . . . 'A stock dividend really takes nothing from the property of the
corporation, and adds nothing to the interests of the shareholders. Its property is not diminished and their
interest are not increased. . . . The proportional interest of each shareholder remains the same. . . .' In short,
the corporation is no poorer and the stockholder is no richer then they were before." (Gibbons vs. Mahon, 136
U.S., 549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).
In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice Pitney, speaking for the court, said that
the act employs the term "income" in its natural and obvious sense, as importing something distinct from
principal or capital and conveying the idea of gain or increase arising from corporate activity.
Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speaking for the court said: "An
income may be defined as the gain derived from capital, from labor, or from both combined, provided it be
understood to include profit gained through a sale or conversion of capital assets."
For bookkeeping purposes, when stock dividends are declared, the corporation or company acknowledges a
liability, in form, to the stockholders, equivalent to the aggregate par value of their stock, evidenced by a
"capital stock account." If profits have been made by the corporation during a particular period and not
divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits,"
"surplus account," etc., or the like. None of these, however, gives to the stockholders as a body, much less to
any one of them, either a claim against the going concern or corporation, for any particular sum of money, or a
right to any particular portion of the asset, or any shares sells or until the directors conclude that dividends
shall be made a part of the company's assets segregated from the common fund for that purpose. The
dividend normally is payable in money and when so paid, then only does the stockholder realize a profit or
gain, which becomes his separate property, and thus derive an income from the capital that he has invested.
Until that, is done the increased assets belong to the corporation and not to the individual stockholders.
When a corporation or company issues "stock dividends" it shows that the company's accumulated profits
have been capitalized, instead of distributed to the stockholders or retained as surplus available for
distribution, in money or in kind, should opportunity offer. Far from being a realization of profits of the
stockholder, it tends rather to postpone said realization, in that the fund represented by the new stock has
been transferred from surplus to assets, and no longer is available for actual distribution. The essential and
controlling fact is that the stockholder has received nothing out of the company's assets for his separate use
and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and
accumulations resulting from employment of his money and that of the other stockholders in the business of
the company, still remains the property of the company, and subject to business risks which may result in
wiping out of the entire investment. Having regard to the very truth of the matter, to substance and not to form,
the stockholder by virtue of the stock dividend has in fact received nothing that answers the definition of an
"income." (Eisner vs. Macomber, 252 U.S., 189, 209, 211.)
The stockholder who receives a stock dividend has received nothing but a representation of his increased
interest in the capital of the corporation. There has been no separation or segregation of his interest. All the
property or capital of the corporation still belongs to the corporation. There has been no separation of the
interest of the stockholder from the general capital of the corporation. The stockholder, by virtue of the stock
dividend, has no separate or individual control over the interest represented thereby, further than he had
before the stock dividend was issued. He cannot use it for the reason that it is still the property of the
corporation and not the property of the individual holder of stock dividend. A certificate of stock represented by
the stock dividend is simply a statement of his proportional interest or participation in the capital of the
corporation. For bookkeeping purposes, a corporation, by issuing stock dividend, acknowledges a liability in
form to the stockholders, evidenced by a capital stock account. The receipt of a stock dividend in no way
increases the money received of a stockholder nor his cash account at the close of the year. It simply shows
that there has been an increase in the amount of the capital of the corporation during the particular period,
which may be due to an increased business or to a natural increase of the value of the capital due to
business, economic, or other reasons. We believe that the Legislature, when it provided for an "income tax,"
intended to tax only the "income" of corporations, firms or individuals, as that term is generally used in its
common acceptation; that is that the income means money received, coming to a person or corporation for
services, interest, or profit from investments. We do not believe that the Legislature intended that a mere
increase in the value of the capital or assets of a corporation, firm, or individual, should be taxed as "income."
Such property can be reached under the ordinary from of taxation.
Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in discussing the difference between
"capital" and "income": "That the fundamental relation of 'capital' to 'income' has been much discussed by
economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former
depicted as a reservoir supplied from springs; the latter as the outlet stream, to be measured by its flow during
a period of time." It may be argued that a stockholder might sell the stock dividend which he had acquired. If
he does, then he has received, in fact, an income and such income, like any other profit which he realizes
from the business, is an income and he may be taxed thereon.
There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock
dividends declared, as in the present case. The one is a disbursement to the stockholder of accumulated
earnings, and the corporation at once parts irrevocably with all interest thereon. The other involves no
disbursement by the corporation. It parts with nothing to the stockholder. The latter receives, not an actual
dividend, but certificate of stock which simply evidences his interest in the entire capital, including such as by
investment of accumulated profits has been added to the original capital. They are not income to him, but
represent additions to the source of his income, namely, his invested capital. (DeKoven vs. Alsop, 205, Ill.,
309; 63 L.R.A. 587). Such a person is in the same position, so far as his income is concerned, as the owner of
young domestic animal, one year old at the beginning of the year, which is worth P50 and, which, at the end of
the year, and by reason of its growth, is worth P100. The value of his property has increased, but has had an
income during the year? It is true that he had taxable property at the beginning of the year of the value of P50,
and the same taxable property at another period, of the value of P100, but he has had no income in the
common acceptation of that word. The increase in the value of the property should be taken account of on the
tax duplicate for the purposes of ordinary taxation, but not as income for he has had none.
The question whether stock dividends are income, or capital, or assets has frequently come before the courts
in another form — in cases of inheritance. A is a stockholder in a large corporation. He dies leaving a will by
the terms of which he give to B during his lifetime the "income" from said stock, with a further provision that C
shall, at B's death, become the owner of his share in the corporation. During B's life the corporation issues a
stock dividend. Does the stock dividend belong to B as an income, or does it finally belong to C as a part of
his share in the capital or assets of the corporation, which had been left to him as a remainder by A? While
there has been some difference of opinion on that question, we believe that a great weight of authorities hold
that the stock dividend is capital or assets belonging to C and not an income belonging to B. In the case of
D'Ooge vs. Leeds (176 Mass., 558, 560) it was held that stock dividends in such cases were regarded
as capital and not as income  (Gibbons vs. Mahon, 136 U.S., 549.)
In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The distinction between the title of a
corporation, and the interest of its members or stockholders in the property of the corporation, is familiar and
well settled. The ownership of that property is in the corporation, and not in the holders of shares of its stock.
The interest of each stockholder consists in the right to a proportionate part of the profits whenever dividends is a very different thing from receipt of a "stock dividend." One is an actual receipt of profits; the other is a
are declared by the corporation, during its existence, under its charter, and to a like proportion of the property receipt of a representation of the increased value of the assets of corporation.
remaining, upon the termination or dissolution of the corporation, after payment of its debts." (Minot vs. Paine,
99 Mass., 101; Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.) In the case of Dekoven vs. Alsop In all of the foregoing argument we have not overlooked the decisions of a few of the courts in different parts
(205 Ill ,309, 63 L. R. A. 587) Mr. Justice Wilkin said: "A dividend is defined as a corporate profit set aside, of the world, which have reached a different conclusion from the one which we have arrived at in the present
declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the case. Inasmuch, however, as appeals may be taken from this court to the Supreme Court of the United
dividend is declared, these corporate profits belong to the corporation, not to the stockholders, and are liable States, we feel bound to follow the same doctrine announced by that court.
for corporate indebtedness.
Having reached the conclusion, supported by the great weight of the authority, that "stock dividends" are not
There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock "income," the same cannot be taxes under that provision of Act No. 2833 which provides for a tax upon
dividends declared. The one is a disbursement to the stockholders of accumulated earning, and the income. Under the guise of an income tax, property which is not an income cannot be taxed. When the assets
corporation at once parts irrevocably with all interest thereon. The other involves no disbursement by the of a corporation have increased so as to justify the issuance of a stock dividend, the increase of the assets
corporation. It parts with nothing to the stockholders. The latter receives, not an actual dividend, but should be taken account of the Government in the ordinary tax duplicates for the purposes of assessment and
certificates of stock which evidence in a new proportion his interest in the entire capital. When a cash collection of an additional tax. For all of the foregoing reasons, we are of the opinion, and so decide, that the
becomes the absolute property of the stockholders and cannot be reached by the creditors of the corporation judgment of the lower court should be revoked, and without any finding as to costs, it is so ordered.
in the absence of fraud. A stock dividend however, still being the property of the corporation and not the
stockholder, it may be reached by an execution against the corporation, and sold as a part of the property of
the corporation. In such a case, if all the property of the corporation is sold, then the stockholder certainly
could not be charged with having received an income by virtue of the issuance of the stock dividend. Until the
dividend is declared and paid, the corporate profits still belong to the corporation, not to the stockholders, and
are liable for corporate indebtedness. The rule is well established that cash dividend, whether large or small,
are regarded as "income" and all stock dividends, as capital or assets (Cook on Corporation, Chapter 32,
secs. 534, 536; Davis vs. Jackson, 152 Mass., 58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of
Law, 2d ed., p. 738.)

If the ownership of the property represented by a stock dividend is still in the corporation and to in the holder
of such stock, then it is difficult to understand how it can be regarded as income to the stockholder and not as
a part of the capital or assets of the corporation. (Gibbsons vs. Mahon, supra.) the stockholder has received
nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may
never receive anything, depending upon the final outcome of the business of the corporation. The entire
assets of the corporation may be consumed by mismanagement, or eaten up by debts and obligations, in
which case the holder of the stock dividend will never have received an income from his investment in the
corporation. A corporation may be solvent and prosperous today and issue stock dividends in representation
of its increased assets, and tomorrow be absolutely insolvent by reason of changes in business conditions,
and in such a case the stockholder would have received nothing from his investment. In such a case, if the
holder of the stock dividend is required to pay an income tax on the same, the result would be that he has paid
a tax upon an income which he never received. Such a conclusion is absolutely contradictory to the idea of an
income. An income subject to taxation under the law must be an actual income and not a promised or
prospective income.

The appelle argues that there is nothing in section 25 of Act No 2833 which contravenes the provisions of the
Jones Law. That may be admitted. He further argues that the Act of Congress (U.S. Revenue Act of 1918)
expressly authorized the Philippine Legislatures to provide for an income tax. That fact may also be admitted.
But a careful reading of that Act will show that, while it permitted a tax upon income, the same provided that
income shall include gains, profits, and income derived from salaries, wages, or compensation for personal
services, as well as from interest, rent, dividends, securities, etc. The appellee emphasizes the "income from
dividends." Of course, income received as dividends is taxable as an income but an income from "dividends"

G.R. No. 48532 August 31, 1992
HERNANDO B. CONWI, JAIME E. DY-LIACCO, VICENTE D. HERRERA, BENJAMIN T. ILDEFONSO,
ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP, LEANDRO G. SANTILLAN, and
JAIME A. SOQUES, petitioners, vs. THE HONORABLE COURT OF TAX APPEALS and COMMISSIONER
OF INTERNAL REVENUE, respondents.
G.R. No. 48533 August 31, 1992
ENRIQUE R. ABAD SANTOS, HERNANDO B. CONWI, TEDDY L. DIMAYUGA, JAIME E. DY-LIACCO,
MELQUIADES J. GAMBOA, JR., MANUEL L. GUZMAN, VICENTE D. HERRERA, BENJAMIN T.
ILDEFONSO, ALEXANDER LACSON, JR., ADRIAN O. MICIANO, EDUARDO A. RIALP and JAIME A.
SOQUES, petitioners, vs. THE HONORABLE COURT OF TAX APPEALS and COMMISSIONER OF
INTERNAL REVENUE, respondents.
NOCON, J.:
Petitioners pray that his Court reverse the Decision of the public respondent Court of Tax Appeals,
promulgated September 26, 1977  denying petitioners' claim for tax refunds, and order the Commissioner of
1
Internal Revenue to refund to them their income taxes which they claim to have been erroneously or illegally
paid or collected.
As summarized by the Solicitor General, the facts of the cases are as follows:
Petitioners are Filipino citizens and employees of Procter and Gamble, Philippine
Manufacturing Corporation, with offices at Sarmiento Building, Ayala Avenue, Makati, Rizal.
Said corporation is a subsidiary of Procter & Gamble, a foreign corporation based in
Cincinnati, Ohio, U.S.A. During the years 1970 and 1971 petitioners were assigned, for
certain periods, to other subsidiaries of Procter & Gamble, outside of the Philippines, during
which petitioners were paid U.S. dollars as compensation for services in their foreign
assignments. (Paragraphs III, Petitions for Review, C.T.A. Cases Nos. 2511 and 2594,
Exhs. D, D-1 to D-19). When petitioners in C.T.A. Case No. 2511 filed their income tax
returns for the year 1970, they computed the tax due by applying the dollar-to-peso
conversion on the basis of the floating rate ordained under B.I.R. Ruling No. 70-027 dated
May 14, 1970, as follows:
From January 1 to February 20, 1970 at the conversion rate of P3.90 to
U.S. $1.00;
From February 21 to December 31, 1970 at the conversion rate of P6.25
to U.S. $1.00
Petitioners in C.T.A. Case No. 2594 likewise used the above conversion rate in converting
their dollar income for 1971 to Philippine peso. However, on February 8, 1973 and October
8, 1973, petitioners in said cases filed with the office of the respondent Commissioner,
amended income tax returns for the above-mentioned years, this time using the par value of
the peso as prescribed in Section 48 of Republic Act No. 265 in relation to Section 6 of
Commonwealth Act No. 265 in relation to Section 6 of Commonwealth Act No. 699 as the
basis for converting their respective dollar income into Philippine pesos for purposes of
computing and paying the corresponding income tax due from them. The aforesaid
computation as shown in the amended income tax returns resulted in the alleged
overpayments, refund and/or tax credit. Accordingly, claims for refund of said over-
payments were filed with respondent Commissioner. Without awaiting the resolution of the
Commissioner of the Internal Revenue on their claims, petitioners filed their petitioner for
review in the above-mentioned cases.
Respondent Commissioner filed his Answer to petitioners' petition for review in C.T.A. Case
No. 2511 on July 31, 1973, while his Answer in C.T.A. Case No. 2594 was filed on August
7, 1974.
Upon joint motion of the parties on the ground that these two cases involve common
question of law and facts, that respondent Court of Tax Appeals heard the cases jointly. In
its decision dated September 26, 1977, the respondent Court of Tax Appeals held that the
proper conversion rate for the purpose of reporting and paying the Philippine income tax on
the dollar earnings of petitioners are the rates prescribed under Revenue Memorandum
Circulars Nos. 7-71 and 41-71. Accordingly, the claim for refund and/or tax credit of
petitioners in the above-entitled cases was denied and the petitions for review dismissed,
with costs against petitioners. Hence, this petition for review on certiorari. 
2
Petitioners claim that public respondent Court of Tax Appeals erred in holding:
1. That petitioners' dollar earnings are receipts derived from foreign exchange transactions.
2. That the proper rate of conversion of petitioners' dollar earnings for tax purposes in the prevailing free
market rate of exchange and not the par value of the peso; and
3. That the use of the par value of the peso to convert petitioners' dollar earnings for tax purposes into
Philippine pesos is "unrealistic" and, therefore, the prevailing free market rate should be the rate used.
Respondent Commissioner of Internal Revenue, on the other hand, refutes petitioners' claims as follows:
At the outset, it is submitted that the subject matter of these two cases are Philippine
income tax for the calendar years 1970 (CTA Case No. 2511) and 1971 (CTA Case No.
2594) and, therefore, should be governed by the provisions of the National Internal
 Revenue Code and its implementing rules and regulations, and not by the provisions of
Central Bank Circular No. 42 dated May 21, 1953, as contended by petitioners.
Section 21 of the National Internal Revenue Code, before its amendment by Presidential
Decrees Nos. 69 and 323 which took effect on January 1, 1973 and January 1, 1974,
respectively, imposed a tax upon the taxable net income received during each taxable year
from all sources by a citizen of the Philippines, whether residing here or abroad.
Petitioners are citizens of the Philippines temporarily residing abroad by virtue of their
employment. Thus, in their tax returns for the period involved herein, they gave their legal
residence/address as c/o Procter & Gamble PMC, Ayala Ave., Makati, Rizal (Annexes "A" to
"A-8" and Annexes "C" to "C-8", Petition for Review, CTA Nos. 2511 and 2594).
Petitioners being subject to Philippine income tax, their dollar earnings should be converted
into Philippine pesos in computing the income tax due therefrom, in accordance with the
provisions of Revenue Memorandum Circular No. 7-71 dated February 11, 1971 for 1970
income and Revenue Memorandum Circular No. 41-71 dated December 21, 1971 for 1971
income, which reiterated BIR Ruling No. 70-027 dated May 4, 1970, to wit:
For internal revenue tax purposes, the free marker rate of conversion
(Revenue Circulars Nos. 7-71 and 41-71) should be applied in order to
determine the true and correct value in Philippine pesos of the income of
petitioners. 3
After a careful examination of the records, the laws involved and the jurisprudence on the matter, We are
inclined to agree with respondents Court of Tax Appeals and Commissioner of Internal Revenue and thus vote
to deny the petition.
This basically an income tax case. For the proper resolution of these cases income may be defined as an
amount of money coming to a person or corporation within a specified time, whether as payment for services,
interest or profit from investment. Unless otherwise specified, it means cash or its equivalent.   Income can
4
also be though of as flow of the fruits of one's labor. 
5
Petitioners are correct as to their claim that their dollar earnings are not receipts derived from foreign
exchange transactions. For a foreign exchange transaction is simply that — a transaction in foreign exchange,
foreign exchange being "the conversion of an amount of money or currency of one country into an equivalent
amount of money or currency of another."   When petitioners were assigned to the foreign subsidiaries of
6
Procter & Gamble, they were earning in their assigned nation's currency and were ALSO spending in said
currency. There was no conversion, therefore, from one currency to another.
Public respondent Court of Tax Appeals did err when it concluded that the dollar incomes of petitioner fell
under Section 2(f)(g) and (m) of C.B. Circular No. 42.  7
The issue now is, what exchange rate should be used to determine the peso equivalent of the foreign
earnings of petitioners for income tax purposes. Petitioners claim that since the dollar earnings do not fall
within the classification of foreign exchange transactions, there occurred no actual inward remittances, and,
therefore, they are not included in the coverage of Central Bank Circular No. 289 which provides for the
specific instances when the par value of the peso shall not be the conversion rate used. They conclude that
their earnings should be converted for income tax purposes using the par value of the Philippine peso.
Respondent Commissioner argues that CB Circular No. 289 speaks of receipts for export products, receipts of
sale of foreign exchange or foreign borrowings and investments but not income tax. He also claims that he
had to use the prevailing free market rate of exchange in these cases because of the need to ascertain the
true and correct amount of income in Philippine peso of dollar earners for Philippine income tax purposes.
A careful reading of said CB Circular No. 289 8 shows that the subject matters involved therein are export products, invisibles, receipts of foreign
exchange, foreign exchange payments, new foreign borrowing and
investments — nothing by way of income tax payments. Thus, petitioners are in error by concluding that since C.B. Circular No. 289 does not apply to them, the par value of the
peso should be the guiding rate used for income tax purposes.
The dollar earnings of petitioners are the fruits of their labors in the foreign subsidiaries of Procter & Gamble.
It was a definite amount of money which came to them within a specified period of time of two yeas as
payment for their services.
Section 21 of the National Internal Revenue Code, amended up to August 4, 1969, states as follows:
Sec. 21. Rates of tax on citizens or residents. — A tax is hereby imposed upon the taxable
net income received during each taxable year from all sources by every individual, whether
a citizen of the Philippines residing therein or abroad or an alien residing in the Philippines,
determined in accordance with the following schedule:
x x x           x x x          x x x
And in the implementation for the proper enforcement of the National Internal Revenue Code, Section 338
thereof empowers the Secretary of Finance to "promulgate all needful rules and regulations" to effectively
enforce its provisions.  9
Pursuant to this authority, Revenue Memorandum Circular Nos. 7-71   and 41-71   were issued to prescribed 10 11
a uniform rate of exchange from US dollars to Philippine pesos for INTERNAL REVENUE TAX PURPOSES
for the years 1970 and 1971, respectively. Said revenue circulars were a valid exercise of the authority given
to the Secretary of Finance by the Legislature which enacted the Internal Revenue Code. And these are
presumed to be a valid interpretation of said code until revoked by the Secretary of Finance himself.  12
Petitioners argue that since there were no remittances and acceptances of their salaries and wages in US
dollars into the Philippines, they are exempt from the coverage of such circulars. Petitioners forget that they
are citizens of the Philippines, and their income, within or without, and in these cases wholly without, are
subject to income tax. Sec. 21, NIRC, as amended, does not brook any exemption.
Since petitioners have already paid their 1970 and 1971 income taxes under the uniform rate of exchange
prescribed under the aforestated Revenue Memorandum Circulars, there is no reason for respondent
Commissioner to refund any taxes to petitioner as said Revenue Memorandum Circulars, being of long
standing and not contrary to law, are valid. 13
Although it has become a worn-out cliche, the fact still remains that "taxes are the lifeblood of the government"
and one of the duties of a Filipino citizen is to pay his income tax.
WHEREFORE, the petitioners are denied for lack of merit. The dismissal by the respondent Court of Tax
Appeals of petitioners' claims for tax refunds for the income tax period for 1970 and 1971 is AFFIRMED.
Costs against petitioners. SO ORDERED.
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.
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.

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

G.R. No. 228539 June 26, 2019
ASSOCIATION OF NON-PROFIT CLUBS, INC. (ANPC), HEREIN REPRESENTED BY ITS AUTHORIZED
REPRESENTATIVE, MS. FELICIDAD M. DEL ROSARIO, Petitioner vs. BUREAU OF INTERNAL REVENUE
(BIR), HEREIN REPRESENTED BY HON. COMMISSIONER KIM S. JACINTO-HENARES, Respondent
DECISION
PERLAS-BERNABE, J.:
Assailed in this petition for review on certiorari  are the Decision  dated July 1, 2016 and the Order  dated
1 2 3
November 7, 2016 of the Regional Trial Court of Makati City, Branch 134 (RTC), in Special Civil Case No. 14-
985, which denied petitioner Association of Non-Profit Clubs, Inc. (ANPC)'s petition  for declaratory relief,
4
thereby upholding in full the validity of Revenue Memorandum Circular (RMC) No. 35-2012. 5
The Facts
On August 3, 2012, respondent the Bureau of Internal Revenue (BIR) issued RMC No. 35-2012, entitled
"Clarifying the Taxability of Clubs Organized and Operated Exclusively for Pleasure, Recreation, and Other
Non-Profit Purposes,"  which was addressed to all revenue officials, employees, and others concerned for
6 is a mere amplification of the existing law and the rules and regulations of the BIR on the matter, positing that
their guidance regarding the income tax and Valued Added Tax (VAT) liability of the said recreational clubs.
7 the said Circular merely explained that by removing recreational clubs from the list of tax exempt entities or
On the income tax component, RMC No. 35-2012 states that "[c]lubs which are organized and operated
exclusively for pleasure, recreation, and other non-profit purposes are subject to income tax under the
National Internal Revenue Code [(NIRC)] of 1997,  as amended [(1997 NIRC)]."  The BIR justified the
8 9
foregoing interpretation based on the following reasons:
According to the doctrine of casus omissus pro omisso habendus est, a person, object, or thing omitted from
an enumeration must be held to have been omitted intentionally. The provision in the (1977 Tax Code] which
granted income tax exemption to such recreational clubs was omitted in the current list of tax exempt
corporations under [the 1997 NIRC], as amended. Hence, the income of recreational clubs from whatever
source, including but not limited to membership fees, assessment dues, rental income, and service
fees are subject to income tax.  (Emphasis and underscoring supplied)
10
Likewise, on the VAT component, RMC No. 35-2012 provides that "the gross receipts of recreational clubs
including but not limited to membership fees, assessment dues, rental income, and service fees
are subject to VAT."  As basis, the BIR relied on Section 105,  Chapter I, Title IV of the 1997 NIRC, which
11 12
states that even a nonstock, nonprofit private organization or government entity is liable to pay VAT on the
sale of goods or services. 13
On October 25, 2012, ANPC, along with the representatives of its member clubs, invited Atty. Elenita
Quimosing (Atty. Quimosing), Chief of Staff, Operations Group of the BIR, to discuss "specifically the effects
of the said [C]ircular and to seek clarification and advice from the BIR on how it will affect the operational
requirements of each club and their members/stakeholders."  During their meeting, Atty. Quimosing discussed
14
the basis and effects of RMC No. 35-2012, and further suggested that the attendees submit a position paper
to the BIR expressing their concerns. 15
Consequently, ANPC submitted its position paper,  requesting "the non-application of RMC [No.] 35-2012 for
16
income tax and VAT liability on membership fees, association dues, and fees of similar nature collected by
[the] exclusive membership clubs from [their] members which are used to defray the expenses of the said
clubs."  However, despite the lapse of two (2) years, the BIR has not acted upon the request, and all the
17
member clubs of ANPC were subjected to income tax and VAT on all membership fees, assessment dues,
and service fees. 18
Aggrieved, ANPC, on behalf of its club members, filed a petition  for declaratory relief before the RTC on
19
September 17, 2014, seeking to declare RMC No. 35-2012 invalid, unjust, oppressive, confiscatory, and in
violation of the due process clause of the Constitution.  ANPC argued that in issuing RMC No. 35-2012, the
20
BIR acted beyond its rule-making authority in interpreting that payments of membership fees, assessment
dues, and service v fees are considered as income subject to income tax, as well as a sale of service that is
subject to VAT. 21
For its part, the Office of the Solicitor General (OSG), on behalf of the BIR, sought the dismissal of the petition
for ANPC's failure to exhaust all the available administrative remedies. It also argued that RMC No. 35- 2012
corporations, Congress intended to subject them to income tax and VAT under the 1997 NIRC. 22
The RTC Ruling
In a Decision  dated July 1, 2016, the RTC denied the petition for declaratory relief  and upheld the validity
23 24
and constitutionality of RMC No. 35-2012.  On the procedural issue, the RTC found that there was no violation
25
of the doctrine of exhaustion of administrative remedies, since judicial intervention was urgent in light of the
impending imposition of taxes on the membership fees and assessment dues paid by the members of the
exclusive clubs.  As to the substantive issue, the RTC found that given the apparent intent of Congress to
26
subject recreational clubs to taxes, the BIR, being the administrative agency concerned with the
implementation of the law, has the power to make such an interpretation through the issuance of RMC No. 35-
2012. As an interpretative rule issued well within the powers of the BIR, the same need not be published and
neither is a hearing required for its validity.
27
Undaunted, ANPC sought reconsideration,  which the RTC denied in an Order  dated November 7, 2016.
28 29
Raising pure questions of law, ANPC, herein represented by its authorized representative, Ms. Felicidad M.
Del Rosario, filed the instant petition for review on certiorari directly before the Court.
The Issue Before the Court
The essential issue for the Court's resolution is whether or not the RTC erred in upholding in full the validity of
RMC No. 35-2012.
The Court's Ruling
The petition is partly meritorious.
I.
The Court first resolves the procedural issues.
In its Comment,  the BIR, through the OSG, seeks the dismissal of the present petition on the ground that
30
ANPC violated the doctrine of hierarchy of courts due to its direct resort before the Court.  Moreover, it asserts
31
that ANPC violated the doctrine of exhaustion of available administrative remedies, pointing out that ANPC
should have first elevated the matter to the Secretary of Finance for review pursuant to Section 4,  Title I of
32
the 1997 NIRC. 33
The contentions are untenable.
First, the Court holds that there was no violation of the doctrine of hierarchy of courts because the present
petition for review on certiorari, filed pursuant to Section 2 (c), Rule 41 in relation to Rule 45 of the Rules of
Court, is the sole remedy to appeal a decision of the RTC in cases involving pure questions of law. The
doctrine of hierarchy of courts is violated only when relief may be had through multiple fora having concurrent
jurisdiction over the case, such as in petitions for certiorari, mandamus, and prohibition which are concurrently
cognizable either by the Regional Trial Courts, the Court of Appeals, or the Supreme Court. In Uy v.
Contreras: 34
[W]hile it is true that this Court, the Court of Appeals, and the Regional Trial Courts have concurrent original
jurisdiction to issue writs of certiorari, prohibition, mandamus, quo warranto, and habeas corpus, such
concurrence does not accord litigants unrestrained freedom of choice of the court to which application therefor
may be directed. There is a hierarchy of courts determinative of the venue of appeals which should
also serve as a general determinant of the proper forum for the application for the extraordinary writs.
A becoming regard for this judicial hierarchy by the petitioner and her lawyers ought to have led them to file
the petition with the proper Regional Trial Court.  (Emphasis and underscoring supplied)
35
Clearly, the correctness of the BIR's interpretation of the 1997 NIRC under the assailed RMC is a pure
question of law,  because the same does not involve an examination of the probative value of the evidence
36
presented by the litigants or any of them.  Thus, being the only remedy to appeal the RTC's ruling upholding
37
the Circular's validity on a purely legal question, direct resort to this Court, through a Rule 45 petition, was
correctly availed by ANPC.
Anent the issue of exhaustion of administrative remedies, the Court likewise holds that the said doctrine was
not transgressed.
At the onset, it is apt to point out that RMC No. 35-2012 only clarified the taxability (particularly, income tax
and VAT liability) of clubs organized and operated exclusively for pleasure, recreation, and other non-profit
purposes based on the BIR's own interpretation of the NIRC provisions on income tax and VAT. Evidently, it
was not designed "to implement a primary legislation by providing the details thereof' as in a legislative rule;
but rather, was intended only to "provide guidelines to the law which the administrative agency is in charge of
enforcing,"  as the said Circular was, in fact, addressed to "[a]ll [r]evenue [o]fficials, [e]mployees[,] and [o]thers
38
[c]oncerned"  to guide them in the enforcement of income tax and VAT laws against fees collected by the said
39
clubs.
Given its nature, RMC No. 35-2012 is therefore subject to the administrative review of the Secretary of
Finance pursuant to Section 4, Title I of the 1997 NIRC, which provides:
Section 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax Cases. - The power
to interpret the provisions of this Code and other tax laws shall be under the exclusive and original jurisdiction
of the Commissioner, subject to review by the Secretary of Finance.
x x x x (Emphases supplied)
Thus, as dictated by the rule on exhaustion of administrative remedies,  the validity of RMC No. 35-2012
40
should have been first subjected to the review of the Secretary of Finance before ANPC sought judicial
recourse with the RTC.
However, as exceptions to this rule, when the issue involved is purely a legal question (as above-explained),
or when there are circumstances indicating the urgency of judicial intervention  - as in this case where
41
membership fees, assessment dues, and the like of all recreational clubs would be imminently subjected to
income tax and VAT - then the doctrine of exhaustion of administrative remedies may be relaxed.
Accordingly, ANPC's recourse to the RTC and now, before this Court are permissible and hence, are not
grounds to dismiss this case. That being said, the Court now proceeds to resolve the substantive issue on
whether or not RMC No. 35-2012 is valid.
II.
To recount, RMC No. 35-2012 is an interpretative rule issued by the BIR to guide all revenue officials,
employees, and others concerned in the enforcement of income tax and VAT laws against clubs organized
and operated exclusively for pleasure, recreation, and other non-profit purposes ("recreational clubs" for
brevity).
As to its income tax component, RMC No. 35-2012 provides the interpretation that since the old tax exemption
previously accorded under Section 21 (h),  Chapter III, Title II of Presidential Decree No. 1158, otherwise
42
known as the "National Internal Revenue Code of 1977"  (1977 Tax Code), to recreational clubs was deleted
43
in the 1997 NIRC, then the income of recreational clubs from whatever source, including but not limited
to membership fees, assessment dues, rental income, and service fees, is subject to income tax.
The interpretation is partly correct.
Indeed, applying the doctrine of casus omissus pro omisso habendus est (meaning, a person, object or thing
omitted from an enumeration must be held to have been omitted intentionally ) , the fact that the 1997 NIRC
44
omitted recreational clubs from the list of exempt organizations under the 1977 Tax Code evinces the
deliberate intent of Congress to remove the tax income exemption previously accorded to these clubs. As
such, the income that recreational clubs derive "from whatever source"  is now subject to income tax under
45
the provisions of the 1997 NIRC.
However, notwithstanding the correctness of the above-interpretation, RMC No. 35-2012 erroneously foisted
a sweeping interpretation that membership fees and assessment dues are sources of income of
recreational clubs from which income tax liability may accrue, viz.:
The provision in the [1977 Tax Code] which granted income tax exemption to such recreational clubs was
omitted in the current list of tax exempt corporations under the [1997 NIRC], as amended. Hence, the income
of recreational clubs from whatever source, including but not limited to membership fees, assessment
dues, rental income, and service fees [is] subject to income tax.  (Emphases and underscoring supplied)
46
The distinction between "capital" and "income" is well-settled in our jurisprudence. As held in the early case
of Madrigal v. Rafferty,  "capital" has been delineated as a "fund" or "wealth," as opposed to "income" being
47
"the flow of services rendered by capital" or the "service of wealth":
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 income. Capital is
wealth, while income is the service of wealth. (See Fisher, "The Nature of Capital and Income.") The
Supreme Court of Georgi;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.)  (Emphases and underscoring supplied)
48
In Conwi v. Court of Tax Appeals,  the Court elucidated that "income may be defined as an amount of money
49
coming to a person or corporation within a specified time, whether as payment for services, interest or
profit from investment. Unless otherwise specified, it means cash or its equivalent. Income can also be
thought of as a flow of the fruits of one's labor." 50
As correctly argued by ANPC, membership fees, assessment dues, and other fees of similar nature only
constitute contributions to and/or replenishment of the funds for the maintenance and operations of
the facilities offered by recreational clubs to their exclusive members.  They represent funds "held in
51
trust" by these clubs to defray their operating and general costs and hence, only constitute infusion of
capital.  52
Case law provides that in order to constitute "income," there must be realized "gain."  Clearly, because of the
53
nature of membership fees and assessment dues as funds inherently dedicated for the maintenance,
preservation, and upkeep of the clubs' general operations and facilities, nothing is to be gained from their
collection. This stands in contrast to the fees received by recreational clubs coming from their income-
generating facilities, such as bars, restaurants, and food concessionaires, or from income-generating
activities, like the renting out of sports equipment, services, and other accommodations: In these latter
examples, regardless of the purpose of the fees' eventual use, gain is already realized from the moment they
are collected because capital maintenance, preservation, or upkeep is not their pre-determined purpose. As
such, recreational clubs are generally free to use these fees for whatever purpose they desire and thus,
considered as unencumbered "fruits" coming from a business transaction.
Further, given these recreational clubs' non-profit nature, membership fees and assessment dues cannot be
considered as funds that would represent these clubs' interest or profit from any investment. In fact, these
fees are paid by the clubs' members without any expectation of any yield or gain (unlike in stock
subscriptions), but only for the above-stated purposes and in order to retain their membership therein.
In fine, for as long as these membership fees, assessment dues, and the like are treated as collections
by recreational clubs from their members as an inherent consequence of their membership, and are,
by nature, intended for the maintenance, preservation, and upkeep of the clubs' general operations
and facilities, then these fees cannot be classified as "the income of recreational clubs from whatever
source" that are "subject to income tax."  Instead, they only form part of capital from which no income
54
tax may be collected or imposed.
It is a well-enshrined principle in our jurisdiction that the State cannot impose a tax on capital as it constitutes
an unconstitutional confiscation of property. As the Court held in Chamber of Real Estate and Builders'
Associations, Inc. v. Romulo: 55
As a general rule, the power to tax is plenary and unlimited in its range, acknowledging in its very nature no
limits, so that the principal check against its abuse is to be found only in the responsibility of the legislature
(which imposes the tax) to its constituency who are to pay it. Nevertheless, it is circumscribed by
constitutional limitations. At the same time, like any other statute, tax legislation carries a presumption of
constitutionality.
The constitutional safeguard of due process is embodied in the fiat "[no] person shall be deprived of life,
liberty or property without due process of law." In Sison, Jr. v. Ancheta [215 Phil. 582 (1984)], we held that
the due process clause may properly be invoked to invalidate, in appropriate cases, a revenue
measure when it amounts to a confiscation of property. But in the same case, we also explained that we
will not strike down a revenue measure as unconstitutional (for being violative of the due process clause) on
the mere allegation of arbitrariness by the taxpayer. There must be a factual foundation to such an
unconstitutional taint. This merely adheres to the authoritative doctrine that, where the due process clause is
invoked, considering that it is not a fixed rule but rather a broad standard, there is a need for proof of such
persuasive character.
xxxx
Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is not
income.  In other words, it is income, not capital, which is subject to income tax. x x x.  (Emphases supplied)
1âшphi1
56
Section 105. Persons Liable.- Any person who, in the course of trade or business, sells, barters, exchanges,
leases goods or properties, renders services, and any person who imports goods shall be subject to the
value-added tax (VAT) imposed in Sections 106 to 108 of this Code.
The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer,
transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts
of sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716.
The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial or an
economic activity, including transactions incidental thereto, by any person regardless of whether or not the
person engaged therein is a nonstock, nonprofit private organization (irrespective of the disposition of its net
income and whether or not it sells exclusively to members or their guests), or government entity.
The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the
Philippines by nonresident foreign persons shall be considered as being rendered in the course of trade or
business. (Emphases supplied)
As ANPC aptly pointed out, membership fees, assessment dues, and the like are not subject to VAT because
in collecting such fees, the club is not selling its service to the members. Conversely, the members are not
buying services from the club when dues are paid; hence, there is no economic or commercial activity to
speak of as these dues are devoted for the operations/maintenance of the facilities of the organization.  As
64

In Misamis Oriental Association of Coco Traders, Inc. v. Department of Finance Secretary,  the Court held
57
such, there could be no "sale, barter or exchange of goods or properties, or sale of a service" to
that "[a]s a matter of power[,] a court, when confronted with an interpretative rule, [such as RMC No. 35-2012,] speak of, which would then be subject to VAT under the 1997 NIRC.
is free to (i) give the force of law to the rule; (ii) go to the opposite extreme and substitute its judgment; or (iii)
give some intermediate degree of authoritative weight to the interpretative rule."  Thus, by sweepingly
58
WHEREFORE, the petition is GRANTED. The Decision dated July 1, 2016 and the Order dated November 7,
including in RMC No. 35-2012 all membership fees and assessment dues in its classification of "income of 2016 of the Regional Trial Court of Makati City, Branch 134, in Special Civil Case No. 14-985, are hereby SET
recreational clubs from whatever source'' that are "subject to income tax,"  the BIR exceeded its rule-making
59
ASIDE. The Court DECLARES that membership fees, assessment dues, and fees of similar nature collected
authority. Case law holds that: by clubs which are organized and operated exclusively for pleasure, recreation, and other nonprofit purposes
do not constitute as: (a) "the income of recreational clubs from whatever source" that are "subject to income
[T]he rule-making power of administrative agencies cannot be extended to amend or expand statutory tax"; and (b) part of the "gross receipts of recreational clubs" that are "subject to [Value Added Tax]."
requirements or to embrace matters not originally encompassed by the law. Administrative regulations should Accordingly, Revenue Memorandum Circular No. 35-2012 should be interpreted in accordance with this
always be in accord with the provisions of the statute they seek to carry into effect, and any resulting Decision.
inconsistency shall be resolved in favor of the basic law. 60

SO ORDERED.
Accordingly, the Court hereby declares the said interpretation to be invalid, and in consequence, sets aside
the ruling of the RTC.

In the same way, the Court declares as invalid the BIR's interpretation in RMC No. 35-2012 that membership
fees, assessment dues, and the like are part of "the gross receipts of recreational clubs" that are "subject to
VAT." 61

It is a basic principle that before a transaction is imposed VAT, a sale, barter or exchange of goods or
properties, or sale of a service is required.  This is true even if such sale is on a cost-reimbursement
62

basis.  Section 105, Chapter I, Title IV of the 1997 NIRC reads:

63
 LAZARO-JAVIER, J.:

The Cases

These twin cases refer to the: 1) Petition for Review filed by the Bureau of Intemal Revenue (BIR) (G.R. No.
215801); and 2) Special Civil Action for Certiorari initiated by the First E-Bank Tower Condominium Corp.
(First E-Bank) (G.R. No. 218924). Both cases assail the following dispositions of the Court of Appeals in CA-
G.R. CV No. 102266 entitled "In the Matter of Declaratory Relief on the Validity of BIR Revenue Memorandum
Circular No. 65-2012 'Clarifying the Taxability of Association Dues, Membership Fees and Other Assessments
!Charges Collected by Condominium Corporations, 'First E-Bank Tower Condominium Corp. v. Bureau of
Internal Revenue ( BIR ) represented by its Commissioner Kim S.Jacinto-Henares, et al."

1) Resolution1 dated June 26, 2014 dismissing for alleged lack of jurisdiction the respective appeals of the
First E-Bank and the BIR et al., viz.:

It appearing from the records that the subject matter of the instant appeal is the Resolution dated 05
September 2013 of the RTC-Branch 146, Makati City, declaring "to have been invalidly issued" BIR Revenue
Memorandum Circular No. 65-2012 dated 31 October 2 012 which imposed 12% value added tax and 32%
income tax on association dues/membership fees and other charges collected by condominium corporation
from its members and tenants, taking into account Section 7 (a) of Republic Act No. 9282 (which took effect
on 23 April 2004) which expressly provides that the Court of Tax Appeals has exclusive appellate jurisdiction
over "Decisions, orders or resolutions of the Regional Trial Courts in local tax cases originally decided or
resolved by them in the exercise of their original or appellate jurisdiction," considering that the Court of Tax
Appeals is a highly specialized body specifically created for the purpose of reviewing tax cases and resolving
tax problems, the instant appeal is hereby DISMISSED outright for lack of jurisdiction over the nature and
[ G.R. No. 215801, January 15, 2020 ]
subject matter of the action.

IN THE MATTER OF DECLARATORY RELIEF ON THE VALIDITY OF BIR REVENUE MEMORANDUM

The Compliance/Manifestation dated 16 May 2014 of RTC Judge Encarnacion Jaja G. Moya and Branch
CIRCULAR NO. 65-2012 "CLARIFYING THE TAXABILITY OF ASSOCIATION DUES, MEMBERSHIP FEES
Clerk of Court Therese Lynn R. Bandong, Manifestations dated 29 May 2014 and 30 May 2014 of First E-
AND OTHER ASSESSMENTS/CHARGES COLLECTED BY CONDOMINIUM CORPORATIONS"
Bank Tower Condominium Corporation and the Manifestation dated 02 June 2014 ofthe Republic ofthe
Philippines are NOTED.
G.R. No. 218924
Let the instant appeal be considered CLOSED and TERMINATED.
BUREAU OF INTERNAL REVENUE (BIR), AS HEREIN REPRESENTED BY ITS COMMISSIONER KIM S.
JACINTO-HENARES AND REVENUE DISTRICT OFFICER (RDO) RICARDO B. ESPIRITU, PETITIONER,
Let the original records be returned to the trial court.
VS. FIRST E-BANK TOWER CONDOMINIUM CORP., RESPONDENT.

SO ORDERED.
IN THE MATTER OF DECLARATORY RELIEF ON THE VALIDITY OF BIR REVENUE MEMORANDUM
CIRCULAR NO. 65-2012 "CLARIFYING THE TAXABILITY OF ASSOCIATION DUES, MEMBERSHIP FEES
AND OTHER ASSESSMENTS/CHARGES COLLECTED BY CONDOMINIUM CORPORATIONS" 2) Resolution2 dated November 27, 2014 denying the parties' respective motions for reconsideration.

FIRST E-BANK TOWER CONDOMINIUM CORP., PETITIONER, VS. BUREAU OF INTERNAL REVENUE The Facts
(BIR), AS HEREIN REPRESENTED BY ITS COMMISSIONER KIM S. JACINTO-HENARES,*
RESPONDENT.
The First E-Bank filed the petition below for declaratory relief seeking to declare as invalid Revenue
Memorandum Circular No. 65-2012 (RMC No. 65-2012) dated October 31, 2012.3 The case was raffled to the
Regional Trial Court, Branch 146, Makati City.
RMC No. 65-2012 entitled "Clarifying the Taxability of Association Dues, Membership Fees and Other
Assessments/ Charges Collected by Condominium Corporations" relevantly reads:
 x x x
CLARIFICATION
The taxability of association dues, membership fees, and other assessments/charges collected by a
condominium corporation from its members, tenants and other entities are discussed hereunder.
I. Income Tax -- The amounts paid in as dues or fees by members and tenants of a condominium
corporation form part of the gross income of the latter subject to income tax. This is because a
condominium corporation furnishes its members and tenants with benefits, advantages, and
privileges in return for such payments. For tax purposes, the association dues, membership fees,
and other assessments/charges collected by a condominium corporation constitute income payments
or compensation for beneficial services it provides to its members and tenants. The previous
interpretation that the assessment dues are funds which are merely held in trust by a condominium
corporation lacks legal basis and is hereby abandoned.
Moreover, since a condominium corporation is subject to income tax, income payments made to it
are subject to applicable withholding taxes under existing regulations.
II. Value-Added Tax (VAT) -Association dues, membership fees, and other assessments/charges
collected by a condominium corporation are subject to VAT since they constitute income payment or
compensation for the beneficial services it provides to its members and tenants.
Section 105 of the National Internal Revenue Code of 1997, as amended, provides:
"SECTION 105. Persons Liable. -Any person who, in the course of trade or business, sells, barters,
exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject
to the value-added tax (VAT) imposed in Sections 106 to 108 of this Code.
xxx
The phrase 'in the course of trade or business' means the regular conduct or pursuit of a commercial or an
economic activity, including transactions incidental thereto, by any person regardless of whether or not the
person engaged therein is a nonstock, nonprofit private organization (irrespective of the disposition of its net
income and whether or not it sells exclusively to members or their guests), or government entity." (Emphasis
supplied)
The above provision is clear -- even a non-stock, non-profit organization or government entity is liable to pay
VAT on the sale of goods or services. This conclusion was affirmed by the Supreme Court in Commissioner of
Internal Revenue v. Court of Appeals and Commonwealth Management and Services Corporation, G.R. No.
125355, March 30, 2000. In this case, the Supreme Court held:
"(E)ven a non-stock, non-profit organization or government entity, is liable to pay VAT on the sale of goods or
services. VAT is a tax on transactions, imposed at every stage of the distribution process on the sale, barter,
exchange of goods or property, and on the performance of services, even in the absence of profit attributable
thereto. The term "in the course of trade or business" requires the regular conduct or pursuit of a commercial
or an economic activity, regardless of whether or not the entity is profit- oriented.
The definition of the term "in the course of trade or business" incorporated in the present law applies to all
transactions even to those made prior to its enactment. Executive Order No. 273 stated that any person who,
in the course of trade or business, sells, barters or exchanges goods and services, was already liable to pay
VAT. The present law merely stresses that even a nonstock, nonprofit organization or government entity is
liable to pay VAT for the sale of goods and services.
Section 108 of the National Internal Revenue Code of 1997 defines the phrase "sale of services" as the
"performance of all kinds of services for others for a fee, remuneration or consideration. " It includes "the
supply of technical advice, assistance or services rendered in connection with technical management or
administration of any scientific, industrial or commercial undertaking or project."
On February 5, 1998, the Commissioner of Internal Revenue issued BIR Ruling No. 010-98 emphasizing that
a domestic corporation that provided technical, research, management and technical assistance to its
affiliated companies and received payments on a reimbursement-of-cost basis, without any intention of
realizing profit, was subject to VAT on services rendered. In fact, even if such corporation was organized
without any intention of realizing profit, any income or profit generated by the entity in the conduct of its
activities was subject to income tax.
Hence, it is immaterial whether the primary purpose of a corporation indicates that it receives payments for
services rendered to its affiliates on a reimbursement-on-cost basis only, without realizing profit, for purposes
of determining liability for VAT on services rendered. As long as the entity provides service for a fee,
remuneration or consideration, then the service rendered is subject to VAT."
Accordingly, the gross receipts of condominium corporations including association dues, membership fees,
and other assessments/charges are subject to VAT, income tax and income payments made to it are subject
to applicable withholding taxes under existing regulations.4
 x x x
The First E-Bank's Allegations
In its Petition dated December 20, 2012, the First E-Bank essentially alleged: It was a non-stock non-profit
condominium corporation. It owned and possessed, through its members, a condominium office building.
RMC No. 65-2012 imposed on it two (2) tax liabilities: 1) value-added tax (VAT) of P118,971. 53 to be paid on
December 2012 and every month thereafter; and b) income tax ofP665,904.12 to be paid on or before April
15, 2013 and every year thereafter.5
RMC No. 65-2012 burdened the owners of the condominium units with income tax and VAT on their own
money which they exclusively used for the maintenance and preservation of the building and its premises.
RMC No. 65-2012 was oppressive and confiscatory because it required condominium unit owners to produce
additional amounts for the thirty-two percent (32%) income tax and twelve percent (12%) VAT.6
Through the Makati Commercial Estate Association, Inc., it sent a Letter dated December 5, 2012 to the BIR
Commissioner requesting deferment of RMC No. 65-2012. A Letter dated December 19, 2012 was likewise
sent to Makati City Revenue District Officer Ricardo B. Espiritu informing him of the continuous judicial
consignation of the income tax and VAT payments due under RMC No. 65-2012.7
The BIR et al .'s Comments
Under Comment dated February 11, 2013, the BIR and RDO Espiritu through the Office of the Solicitor
General (OSG) riposted that declaratory relief was no longer proper here considering that RMC No. 65-2012
already took effect on October 31, 2012. The alleged injury which the First E-Bank sought to prevent had
already arisen as of that date.8
By its separate comment,* the BIR's Litigation Division argued that the petition should be dismissed for
violation of the principle of primary jurisdiction. Several condominium corporations had already referred the
issue to the BIR Law Division for further clarification. Ultimately, only the Secretary of Finance had primary
jurisdiction over the issue raised here. Too, a petition for declaratory relief will not prosper if the questioned
statute had already been breached, as in this case. RMC No. 65-2012 was only a clarificatory issuance on
pertinent laws, specifically the National Internal Revenue Code (NIRC). It was merely a restatement of the
BIR's prevailing position on the issue of taxation.9
The First E-Bank's Reply
The First E-Bank replied that judicial consignation of its tax payments under protest was necessary.10
The Trial Court's Ruling
By Resolution11 dated September 5, 2013, the trial court ruled that the First E-Bank correctly resorted to a
petition for declaratory relief for the purpose of invalidating RMC No. 65-2012. On this score, the trial court
declared as invalid RMC No. 65-2012 for it purportedly expanded the law, created an additional tax burden on
condominium corporations, and was issued without the requisite notice and hearing, thus:
As to the validity of the Memorandum Circular issued, it is respondent's contention that it merely clarified and
was simply issued to restate and clarify the prevailing position and ruling of the BIR. It was a mere
interpretation of an existing law which has already been in effect and which was not set to be amended.
However, the same appears to be not true as it goes beyond its objective to clarify the existing statute. The
assailed Revenue Memorandum Circular not merely interpreted or clarified the existing BIR Ruling but in fact
legislated or introduced a new legislation under the mantle of its quasi-legislative authority. The BIR
Commissioner, under the guise of clarifying income tax on association dues, made Revenue Memorandum
Circular effective immediately. In so doing, the passage contravenes the constitutional mandate of due
process of law.12
 x x x
The above cited portion of the Memorandum Circular failed to show what particular law it clarified. Instead it
shows that it merely departed from the several rulings of the Bureau exempting from income tax the
assessments/charges collected by condominium corporations from its members, on the ground that the
collection of association dues and other assessments/charges are merely held in trust to be used solely for
administrative expenses in implementing its purpose. The new circular in effect made its own legislation
abandoning the previous rulings of the BIR which became the practice of the condominium corporations
including herein petitioner. The Revenue Circular changed and departed from the long standing ruling of the
BIR that association dues and other fees and charges collected from members are tax exempt. In so doing, it
abruptly charges from taxpayer an imposition which was then not existing, and worse made it immediately
effective which is prejudicial to the rights of the petitioner. It did not merely interpret or clarify but changed
altogether the long standing rules of the Bureau of Internal revenue.13
 x x x
Moreover, it is already the common business practice of petitioner that the association dues, membership fees
and the like are not included as part of its income and therefore of the VAT. The advent of the Memorandum
Circular 65-2012 issued by the Commissioner changes the tax liability of petitioner in the sense that it is now
subject to tax. It created a new tax burden upon petitioner. Petitioner then could not be faulted to consign
judicially as they claim, the [VAT) amount pending resolution of the petition for declaratory relief herein filed.
Respondent BIR Commissioner should have accorded petitioner the opportunity to be heard, which was the
bone of contention of the letter sent to the Honorable Commissioner which was not acted upon.
The Revenue Memorandum Circular did not only clarify an existing law, but changes its import and
interpretation that in so doing it prejudices the right of the petitioner as a tax payer.14
 x x x
Since the BIR in passing the subject memorandum circular failed to accord respondent or those similarly
situated as a tax payer due notice and opportunity to be heard, before issuing said circular it is this court's
opinion that the issuance was arbitrarily and in violation of the due process clause of the constitution. The
respondent in imposing additional tax burden on petitioner violated the latter's constitutional right to due notice
and hearing.15
 x x x
In another vein, the trial court noted the absence of proof that the First E-Bank actually made a judicial
consignation of its purported tax payments.16
The BIR et al. moved for reconsideration. It argued that the petition was premature, RMC No. 65-2012 was
valid, and the petition for declaratory relief should be dismissed for violating the principle of primary
jurisdiction. For its part, the First E-Bank moved for partial reconsideration, praying that the consigned funds
be released.17
By Order18 dated December 18,2013, the trial court denied the parties' respective motions for
reconsideration.  It reiterated that the First E-Bank properly resorted to a petition for declaratory relief for the
1avvph!1
purpose of invalidating RMC No. 65-2012. It also noted that the First E-Bank appeared to have judicially
consigned the funds only on November 17, 2013, following the resolution of the case on September 5, 2013.
For sure, this judicial consignation, which was belatedly done, cannot justify a modification of the aforesaid
resolution. The trial court, nonetheless, pronounced that the First E-Bank was not precluded from filing the
proper motion to withdraw the consigned amounts upon the finality of the ruling on the validity of RMC 65-
2012.
The Proceedings before the Court of Appeals
Aggrieved, both parties appealed to the Court of Appeals. On one hand, the BIR et al. challenged the trial
court's ruling insofar as it: a) decreed that the First E-Bank correctly availed of the petition for declaratory relief
when it sought to nullify RMC No. 65-2012; and b) declared the same as invalid. On the other hand, the First
E-Bank assailed the trial court's ruling insofar as it declined to order the release of the judicially consigned
amounts.
The Court of Appeals' Dispositions
By its first assailed Resolution dated June 26, 2014, the Court of Appeals dismissed the appeal of the First E-
Bank and the joint appeal of the BIR et al. on ground of lack of jurisdiction. It emphasized that jurisdiction over
the case was exclusively vested in the Court of Tax Appeals since the trial court's impugned resolution
involved a tax matter.
Both the First E-Bank and the BIR et al., moved for reconsideration. They commonly asserted that the Court
of Appeals had appellate jurisdiction over their respective appeals emanating from a petition for declaratory
relief which sought to invalidate RMC No. 65-2012.19
By its second assailed Resolution20 dated November 27, 2014, the Court of Appeals denied the motions for
reconsideration and stressed anew that the Court of Tax Appeals had exclusive jurisdiction over the appeals.
The Present Petitions
In G.R. No. 218924, the First E-Bank initiated, on alleged ground of grave abuse of discretion, a Special Civil
Action for Certiorari21 to nullify the assailed dispositions of the Court of Appeals. According to the First E-
Bank, the Court of Appeals, not the Court of Tax Appeals, has jurisdiction over its appeal since the subject
matter of the case is not local tax or taxes per se but a petition to declare as invalid RMC No. 65-2012. The
Court of Appeals purportedly based its rulings on conjectures and surmises, not on established facts and law.
In G.R. No. 215801,22 the BIR et al. availed ofRu1e 45 of the Revised Rules of Court. They plead the same
legal issue pertaining to which court has jurisdiction over the trial court's decision.
Issues
First: Is a petition for declaratory relief proper for the purpose of invalidating RMC No. 65-2012?
Second: Did the Court of Appeals validly dismiss the twin appeals on ground of lack of jurisdiction?
Third: Is RMC No. 65-2012 valid?
a) Is a condominium corporation engaged in trade or business?
b) Are assoc1atwn dues, membership fees, and other assessments/charges subject to income tax,
value-added tax, and withholding tax?
Fourth: Is the First E-Bank entitled to the release of its judicially consigned tax payments?
Ruling
A petition for declaratory relief is not the proper remedy to seek the invalidation of RMC No. 65-2012
An action for declaratory relief is governed by Section 1, Rule 63 of the Revised Rules of Court, thus:
Section l. Who may file petition. Any person interested under a deed, will, contract or other written instrument,
or whose rights are affected by a statute, executive order or regulation, ordinance, or any other governmental
regulation may, before breach or violation thereof bring an action in the appropriate Regional Trial Court to
determine any question of construction or validity arising, and for a declaration of his rights or duties,
thereunder.
Declaratory relief requires the following elements: (1) the subject matter of the controversy must be a deed,
will, contract or other written instrument, statute, executive order or regulation, or ordinance; (2) the terms of
said documents and the validity thereof are doubtful and require judicial construction; (3) there must have
been no breach of the documents in question; (4) there must be an actual justiciable controversy or the
"ripening seeds" of one between persons whose interests are adverse; (5) the issue must be ripe for judicial
determination; and (6) adequate relief is not available through other means or other forms of action or
proceeding.23
The Court rules that certiorari or prohibition, not declaratory relief, is the proper remedy to assail the validity or
constitutionality of executive issuances. DOTR v. PPSTA24 is apropos:
The Petition for Declaratory Relief is not the proper remedy
One of the requisites for an action for declaratory relief is that it must be filed before any breach or violation of
an obligation. Section 1, Rule
63 of the Rules of Court states, thus:
 x x x
Thus, there is no actual case involved in a Petition for Declaratory Relief . It cannot, therefore, be the proper
vehicle to invoke the judicial review powers to declare a statute unconstitutional.
It is elementary that before this Court can rule on a constitutional issue, there must first be a justiciable
controversy. A justiciable controversy refers to an existing case or controversy that is appropriate or ripe for
judicial determination, not one that is conjectural or merely anticipatory. As We emphasized in Angara v.
Electoral Commission, any attempt at abstraction could only lead to dialectics and barren legal questions and
to sterile conclusions unrelated to actualities.
To question the constitutionality of the subject issuances, respondents should have invoked the expanded
certiorari jurisdiction under Section 1 of Article VIII of the 1987 Constitution . The adverted section defines
judicial power as the power not only "to settle actual controversies involving rights which are legally
demandable and enforceable," but also "to determine whether or not there has been a grave abuse of
discretion amounting to lack or excess of jurisdiction on the part of any branch or instrumentality of the
Government."
There is a grave abuse of discretion when there is patent violation of the Constitution, the law, or existing
jurisprudence. On this score, it has been ruled that "the remedies of certiorari and prohibition are necessarily
broader in scope and reach, and the writ of certiorari or prohibition may be issued to correct errors of
jurisdiction committed not only by a tribunal, corporation, board or officer exercising judicial, quasi-judicial or
ministerial functions, but also to set right, undo[,] and restrain any act of grave abuse of discretion amounting
to lack or excess of jurisdiction by any branch or instrumentality of the Government, even if the latter does not
exercise judicial, quasi-judicial or ministerial functions." Thus, petitions for certiorari and prohibition are the
proper remedies where an action of the legislative branch is seriously alleged to have infringed the
Constitution. (Emphasis supplied   waive such technical requirements when the legal questions to be resolved are of great importance to the
In Diaz v. The Secretary of Finance, et al.,25 the Court, nonetheless, held that a petition for declaratory relief
may be treated as one for prohibition if the case has far-reaching implications and raises questions that need
to be resolved for the public good; or if the assailed act or acts of executive officials are alleged to have
usurped legislative authority, thus:
On August 24, 2010 the Court issued a resolution, treating the petition as one for prohibition rather than one
for declaratory relief, the characterization that petitioners Diaz and Timbol gave their action. The government
has sought reconsideration of the Court's resolution, however, arguing that petitioners' allegations clearly
made out a case for declaratory relief: an action over which the Court has no original jurisdiction. The
government adds, moreover, that the petition does not meet the requirements of Rule 65 for actions for
prohibition since the BIR did not exercise judicial, quasi-judicial, or ministerial functions when it sought to
impose VAT on toll fees. Besides, petitioners Diaz and Timbo !has a plain, speedy, and adequate remedy in
the ordinary course of law against the BIR action in the form of an appeal to the Secretary of Finance.
But there are precedents for treating a petition for declaratory relief as one for prohibition if the case has far-
reaching implications and raises questions that need to be resolved for the public good. The Court has also
held that a petition for prohibition is a proper remedy to prohibit or nullify acts of executive officials that amount
to usurpation of legislative authority.
Here, the imposition of VAT on toll fees has far-reaching implications. Its imposition would impact, not only on
the more than half a million motorists who use the tollways everyday, but more so on the government's effort
to raise revenue for funding various projects and for reducing budgetary deficits. (Emphasis supplied)
Here, RMC No. 65-2012 has far-reaching ramifications among condominium corporations which have
proliferated throughout the country. For numerous Filipino families, professionals, and students have, for quite
sometime now, opted for condominium living as their new way of life. The matter of whether indeed the
contributions of unit owners solely intended for maintenance and upkeep of the common areas of the
condominium building are taxable is imbued with public interest. Suffice it to state that taxes, being the
lifeblood of the government, occupy a high place in the hierarchy of State priorities, hence, all questions
pertaining to their validity must be promptly addressed with the least procedural obstruction.
Notably, the issue at hand has already pended for six (6) years now, first with the trial court, then with the
Court of Appeals, and now with this Court. Hence, to forestall any further delay, instead of remanding the
cases to the Court of Appeals, we here and now write finis to these cases once and for all, Diaz  enunciated:
To dismiss the petition and resolve the issues later, after the challenged VAT has been imposed, could cause
more mischief both to the tax-paying public and the government. A belated declaration of nullity of the BIR
action would make any attempt to refund to the motorists what they paid an administrative nightmare with no
solution. Consequently, it is not only the right, but the duty of the Court to take cognizance of and resolve the
issues that the petition raises.
Although the petition does not strictly comply with the requirements of Rule 65, the Court has ample power to
public. The same may be said of the requirement of locus standi which is a mere procedural requisite.
G.R. No. 218924
The First E-Bank faults the Court of Appeals with grave abuse of discretion amounting to lack or excess of
jurisdiction when the latter dismissed the former's appeal from the trial court's Resolution dated September 5,
2013 and Order dated December 18, 2013.
A petition for certiorari is proper where the impugned dispositions, as in this case, are tainted with grave
abuse of discretion amounting to lack or excess ofjurisdiction.26 More so where a petition for review on
certiorari does not appear to be a plain, speedy, and adequate remedy to address the First E Bank's urgent
concerns on its accumulated supposed tax liabilities which will never get halted until the validity of RMC No.
65-2012 is finally resolved, and considerations of public welfare and public policy compel the speedy
resolution of the cases through the extraordinary remedy of certiorari.
The Court, in some instances, allowed a petition for certiorari to prosper notwithstanding the availability of
appeal. Mallari v. Banco Filipino Savings & Mortgage Bank27  enumerates these instances, viz.:
Indeed, the Court in some instances has allowed a petition for certiorari to prosper notwithstanding the
availability of an appeal, such as, (a) when public welfare and the advancement of public policy dictate it; (b)
when the broader interest of justice so requires; (c) when the writs issued are null; and (d) when the
questioned order amounts to an oppressive exercise of judicial authority.
So must it be.
G.R. No. 215801
On the part of the BIR et al., they opted to pursue the regular route under Rule 45 of the Revised Rules of
Court. Surely, being the beneficiary of the taxes paid by the First E-Bank, the State has no compelling need to
avail of the extraordinary remedy under Rule 65. At any rate, Rule 45 is undoubtedly an available remedy in
the ordinary course of law.
The parties' resort to the Court of Appeals was proper in light of the then prevailing jurisprudence
We now resolve the issue of jurisdiction.
Section 7 of Republic Act No. 9282 (RA 9282)28 outlines the appellate jurisdiction of the Court of Tax
Appeals, viz.:
Sec. 7. Jurisdiction. -The CTA shall exercise:
a. Exclusive appellate jurisdiction to review by appeal, as herein provided:
1. Decisions of the Commissioner of Internal Revenue in cases involving disputed assessments,
refunds of internal revenue taxes, fees or other charges, penalties in relation thereto, or other matters
arising under the National Internal Revenue or other laws administered by the Bureau of Internal
Revenue;
2. Inaction by the Commissioner of Internal Revenue in cases involving disputed assessments,
refunds of internal revenue taxes, fees or other charges, penalties in relations thereto, or other
matters arising under the National Internal Revenue Code or other laws administered by the Bureau
oflnternal Revenue, where the National Internal Revenue Code provides a specific period of action,
in which case the inaction shall be deemed a denial;
3. Decisions, orders or resolutions of the Regional Trial Courts in local tax cases originally decided or
resolved by them in the exercise of their original or appellate jurisdiction;
4. Decisions of the Commissioner of Customs in cases involving liability for customs duties, fees or
other money charges, seizure, detention or release of property affected, fines, forfeitures or other
penalties in relation thereto, or other matters arising under the Customs Law or other laws
administered by the Bureau of Customs;
5. Decisions of the Central Board of Assessment Appeals in the exercise of its appellate jurisdiction
over cases involving the assessment and taxation of real property originally decided by the provincial
or city board of assessment appeals;
6. Decisions of the Secretary of Finance on customs cases elevated to him automatically for review
from decisions of the Commissioner of Customs which are adverse to the Government under Section
2315 of the Tariff and Customs Code;
7. Decisions of the Secretary of Trade and Industry, in the case of non-agricultural product,
commodity or article, and the Secretary of Agriculture in the case of agricultural product, commodity
or article, involving dumping and countervailing duties under Section 301 and 302, respectively, of
the Tariff and Customs Code, and safeguard measures under Republic Act No. 8800, where either
party may appeal the decision to impose or not to impose said duties.
On August 30, 2008, the Court en banc decreed in British American Tobacco v. Camacho, et al. 29 that the
Court of Tax Appeals did not have jurisdiction to pass upon the constitutionality or validity of a law or rule,
thus:
While the above statute confers on the CTA jurisdiction to resolve tax disputes in general, this does not
include cases where the constitutionality of a law or rule is challenged. Where what is assailed is the validity
or constitutionality of a law, or a rule or regulation issued by the administrative agency in the performance of
its quasi-legislative function, the regular courts have jurisdiction to pass upon the same. The determination of
whether a specific rule or set of rules issued by an administrative agency contravenes the law or the
constitution is within the jurisdiction of the regular courts. Indeed, the Constitution vests the power of judicial
review or the power to declare a law, treaty, international or executive agreement, presidential decree, order,
instruction, ordinance, or regulation in the courts, including the regional trial courts. This is within the scope of
judicial power, which includes the authority of the courts to determine in an appropriate action the validity of
the acts of the political departments. Judicial power includes the duty of the courts of justice to settle actual
controversies involving rights which are legally demandable and enforceable, and to determine whether or not
there has been a grave abuse of discretion amounting to lack or excess of jurisdiction on the part of any
branch or instrumentality of the Government. (Emphasis supplied )
The prevailing dictum then was only regular courts had jurisdiction to pass upon the constitutionality or validity
of tax laws and regulations.
On February 4, 2014, the Court en bane recognized that the Court of Tax Appeals possessed all such implied,
inherent, and incidental powers necessary to the full and effective exercise of its appellate jurisdiction over tax
cases. City of Manila v. Judge Grecia-Cuerdo30  is relevant, thus:
A grant of appellate jurisdiction implies that there is included in it the power necessary to exercise it
effectively, to make all orders that will preserve the subject of the action, and to give effect to the final
determination of the appeal. It carries with it the power to protect that jurisdiction and to make the decisions of
the court thereunder effective. The court, in aid of its appellate jurisdiction, has authority to control all auxiliary
and incidental matters necessary to the efficient and proper exercise of that jurisdiction. For this purpose, it
may, when necessary, prohibit or restrain the performance of any act which might interfere with the proper
exercise of its rightful jurisdiction in cases pending before it.
Lastly, it would not be amiss to point out that a court which is endowed with a particular jurisdiction should
have powers which are necessary to enable it to act effectively within such jurisdiction. These should be
regarded as powers which are inherent in its jurisdiction and the court must possess them in order to enforce
its rules of practice and to suppress any abuses of its process and to defeat any attempted thwarting of such
process.
In this regard, Section 1 of RA 9282 states that the CTA shall be of the same level as the CA and shall
possess all the inherent powers of a court of justice.
Indeed, courts possess certain inherent powers which may be said to be implied from a general grant of
jurisdiction, in addition to those expressly conferred on them. These inherent powers are such powers as are
necessary for the ordinary and efficient exercise of jurisdiction; or are essential to the existence, dignity and
functions of the courts, as well as to the due administration of justice; or are directly appropriate, convenient
and suitable to the execution of their granted powers; and include the power to maintain the court's jurisdiction
and render it effective in behalf of the litigants.
Thus, this Court has held that "while a court may be expressly granted the incidental powers necessary to
effectuate its jurisdiction, a grant of jurisdiction, in the absence of prohibitive legislation, implies the necessary
and usual incidental powers essential to effectuate it, and, subject to existing laws and constitutional
provisions, every regularly constituted court has power to do all things that are reasonably necessary for the
administration of justice within the scope of its jurisdiction and for the enforcement of its judgments and
mandates." Hence, demands, matters or questions ancillary or incidental to, or growing out of, the main
action, and coming within the above principles, may be tal{en cognizance of by the court and determined,
since such jurisdiction is in aid of its authority over the principal matter, even though the court may thus be
called on to consider and decide matters which, as original causes of action, would not be within its
cognizance. (Emphasis supplied)
Consequently, the Court held that the authority of the Court of Tax Appeals to take cognizance of petitions for
certiorari against interlocutory orders of the RTC in local tax cases was deemed included in the authority or
jurisdiction granted it by law.
The Court underscored that the grant of appellate jurisdiction to the Court of Tax Appeals included such power
necessary to exercise it effectively. Besides, a split-jurisdiction between the Court of Tax Appeals and the
Court of Appeals is anathema to the orderly administration of justice. "The Court cannot accept that such was
the legislative motive, especially considering that the law expressly confers on the CTA, the tribunal with the
specialized competence over tax and tariff matters, the role of judicial review over local tax cases without
mention of any other court that may exercise such power." 31
On August 16, 2016, in Banco de Oro v. Republic of the Phils., et al., 32 the Court en bane pronounced in no
uncertain terms that the Court of Tax Appeals had jurisdiction to rule on the constitutionality or validity of a tax
law or regulation or administrative issuance, viz.:
The Court of Tax Appeals has undoubted jurisdiction to pass upon the constitutionality or validity of a tax law
or regulation when raised by the taxpayer as a defense in disputing or contesting an assessment or claiming a
refund. It is only in the lawful exercise of its power to pass upon all maters brought before it, as sanctioned by
Section 7 of Republic Act No. 1125, as amended.
This Court, however, declares that the Court of Tax Appeals may likewise take cognizance of cases directly
challenging the constitutionality or validity of a tax law or regulation or administrative issuance (revenue
orders, revenue memorandum circulars, rulings).
Section 7 of Republic Act No. 1125, as amended, is explicit that, except for local taxes, appeals from the
decisions of quasi-judicial agencies (Commissioner of Internal Revenue, Commissioner of Customs, Secretary
of Finance, Central Board of Assessment Appeals, Secretary of Trade and Industry) on tax-related problems
must be brought exclusively to the Court of Tax Appeals.
In other words, within the judicial system, the law intends the Court of Tax Appeals to have exclusive
jurisdiction to resolve all tax problems. Petitions for writs of certiorari against the acts and omissions ofthe said
quasi-judicial agencies should, thus, be filed before the Court of Tax Appeals.
Republic Act No. 9282, a special and later law than Batas Pambansa Big . 129 provides an exception to the
original jurisdiction of the Regional Trial Courts over actions questioning the constitutionality or validity of tax
laws or regulations. Except for local tax cases, actions directly challenging the constitutionality or validity of a
tax law or regulation or administrative issuance may be filed directly before the Court of Tax Appeals.
Furthermore, with respect to administrative issuances (revenue orders, revenue memorandum circulars, or
rulings), these are issued by the Commissioner under its power to make rulings or opinions in connection with
the implementation of the provisions of internal revenue laws. Tax rulings, on the other hand, are official
positions of the Bureau on inquiries of taxpayers who request clarification on certain provisions of the National
Internal Revenue Code, other tax laws, or their implementing regulations. Hence, the determination of the
validity of these issuances clearly falls within the exclusive appellate jurisdiction of the Court of Tax Appeals
under Section 7 (1) of Republic Act No. 1125, as amended, subject to prior review by the Secretary of
Finance, as required under Republic Act No. 8424. (Emphasis supplied)
Banco de Oro further stressed that such undoubted jurisdiction is exclusively vested in the Court of Tax
Appeals whether it is raised by the taxpayer directly or as a defense.
Here, following the trial court's denial of their respective motions for reconsideration, the parties appealed to
the Court of Appeals. On June 26, 2014, the Court of Appeals dismissed the appeals, and on November 27,
2014, denied the parties' motions for reconsideration.33
Based on this sequence of events, the whole time the case was ongoing below, the prevailing doctrine had
been British American Tobacco ordaining that the Court of Tax Appeals did not have jurisdiction to decide the
validity or constitutionality of laws or rules. Consequently, the parties correctly elevated the trial court's
resolution to the Court of Appeals, which should have taken cognizance of, and resolved, the appeals on the
merits.
RMC No. 65-2012 is invalid
We now turn to the substantive issue: Is RMC No. 65-2012 valid?
a) A condominium corporation is not engaged in trade or business
The issue on whether association dues, membership fees, and other assessments/charges collected by a
condominium corporation in the usual course of trade or business is not novel. Yamane v. BA Lepanto
Condominium Corp.34 positively resolved it, viz.:
Obviously, none of these stated corporate purposes are geared towards maintaining a livelihood or the
obtention of profit. Even though the Corporation is empowered to levy assessments or dues from the unit
owners, these amounts collected are not intended for the incurrence of profit by the Corporation or its
members, but to shoulder the multitude of necessary expenses that arise from the maintenance of the
Condominium Project. Just as much is confirmed by Section 1, Article V of the Amended By-Laws, which
enumerate the particular expenses to be defrayed by the regular assessments collected from the unit owners.
These would include the salaries of the employees of the Corporation, and the cost of maintenance and
ordinary repairs of the common areas.
The City Treasurer nonetheless contends that the collection of these assessments and dues are "with the end
view of getting fu11 appreciative living values" for the condominium units, and as a result, profit is obtained
once these units are sold at higher prices. The Court cites with approval the two counterpoints raised by the
Court of Appeals in rejecting this contention. First, if any profit is obtained by the sale of the units, it accrues
not to the corporation but to the unit owner. Second, if the unit owner does obtain profit from the sale of the
corporation, the owner is already required to pay capital gains tax on the appreciated value of the
condominium unit.
Moreover, the logic on this point of the City Treasurer is baffling. By this rationale, every Makati City car owner
may be considered as being engaged in business, since the repairs or improvements on the car may be
deemed oriented towards appreciating the value of the car upon resale. There is an evident distinction
between persons who spend on repairs and improvements on their personal and real property for the purpose
of increasing its resale value, and those who defray such expenses for the purpose of preserving the property.
The vast majority of persons fall under the second category, and it would be highly specious to subject these
persons to local business taxes .The profit motive in such cases is hardly the driving factor behind such
improvements, if it were contemplated at all. Any profit that would be derived under such circumstances would
merely be incidental, if not accidental.
Besides, we shudder at the thought of upholding tax liability on the basis of the standard of "full appreciative
living values," a phrase that defies statutory explication, commonsensical meaning, the English language, or
even definition from Google." Full appreciative living values" is nothing but blather in search of meaning, and
to impose a tax hinged on that standard is both arbitrary and oppressive.
 x x x
Again, whatever capacity the Corporation may have pursuant to its power to exercise acts of ownership over
personal and real property is limited by its stated corporate purposes, which are by themselves further limited
by the Condominium Act .A condominium corporation, while enjoying such powers of ownership, is prohibited
by law from transacting its properties for the purpose of gainful profit. (Emphasis supplied)
xxx
Yamane  did emphasize that a corporation condominium is not designed to engage in activities that generate
income or profit. A discussion on the nature of a condominium corporation is, indubitably, in order.
The creation of the condominium corporation is sanctioned by Republic Act No. 4726 (RA 4726 )35 (The
Condominium Act). Under the law, a condominium is an interest in real property consisting of a separate
interest in a unit in a residential, industrial or commercial building and an undivided interest in common,
directly or indirectly, in the land on which it is located and in other common areas of the building. To enable
the orderly administration over these common areas which the unit owners jointly own, RA 4726 permits the
creation of a condominium corporation for the purpose of holding title to the common areas. The unit owners
shall in proportion to the appurtenant interests of their respective units automatically be members or
shareholders of the condominium corporation to the exclusion of others.36
Sections 10 and 22 of RA 4726 focus on the non-profit purpose of a condominium corporation. Under Section
10,37 the corporate purposes of a condominium corporation are limited to holding the common areas, either in
ownership or any other interest in real property recognized by law; management of the project; and to such
other purposes necessary, incidental, or convenient to the accomplishment of these purposes. Additionally,
Section 10 prohibits the articles of incorporation or by-laws of the condominium corporation from containing
any provisions contrary to the provisions of RA 4726, the enabling or master deed, or the declaration of
restrictions of the condominium project.38
Also, under Section 22,39 the condominium corporation, as the management body, may only act for the
benefit of the condominium owners in disposing tangible and intangible personal property by sale or otherwise
in proportion to the condominium owners' respective interests in the common areas.
Further, Section 940 allows a condominium corporation to provide for the means by which it should be
managed. Specifically, it authorizes a condominium corporation to collect association dues, membership fees,
and other assessments/charges for: a) maintenance of insurance policies; b) maintenance, utility, gardening
and other services benefiting the common areas, for the employment of personnel necessary for the operation
of the building, and legal, accounting and other professional and technical services; c) purchase of materials, Sec. 31. Taxable Income Defined. The term "taxable income" means the pertinent items of gross income
supplies and the like needed by the common areas; d) reconstruction of any portion or portions of any specified in this Code, less deductions if any, authorized for such types of income by this Code or other
damage to or destruction of the project; and e) reasonable assessments to meet authorized expenditures. special laws.

In fine, the collection of association dues, membership fees, and other assessments/charges is purely for the There is no substantial difference between the original definition under RA 8424 and the subsequent definition
benefit of the condominium owners. It is a necessary incident to the purpose to effectively oversee, maintain, under the TRAIN Law. The only difference is that the phrase "and/or personal and additional exemptions" was
or even improve the common areas of the condominium as well as its governance. deleted. Still, both the former and current definitions are consistent--- 'taxable income' refers to "the pertinent
items of gross income specified in this Code." A comparison of RA 8424 and the TRAIN Law shows the items
As held in Yamane "[t]he profit motive in such cases is hardly the driving factor behind such improvements,  if  under gross income insofar as they are relevant to the present case, viz.:
it were contemplated at all. Any profit that would be derived under such circumstances would merely be
incidental, if  not accidental." More, a condominium corporation is especially formed for the purpose of holding
title to the common area and exists only for the benefit of the condominium owners. Nothing more. RA 842445 (the law in effect when RMC No. 65- RA 10963 (signed into law on December 19, 2017
2012 was issued on October 31, 2012) and took effect on January 1, 2018)
RMC No. 65-2012, sharply departs from Yamane  and the law on condominium corporations. It invalidly Section 32. Gross Income. - Section 32. Gross Income.-
declares that the amounts paid as dues or fees by members and tenants of a condominium corporation form
part of the gross income of the latter, thus, subject to income tax, value-added tax, and withholding tax. The
reason given --- a condominium corporation furnishes its members and tenants with benefits, advantages, and (A) General Definition. - Except when otherwise (A) General Definition. - Except when otherwise
privileges in return for such payments, consequently, these payments constitute taxable income or provided in this Title, gross income means all provided in this Title, gross income means all
compensation for beneficial services it provides to its members and tenants, hence, subject to income tax, income derived from whatever source, including (but income derived from whatever source, including (but
value-added tax, and withholding tax. not limited to) the following items: not limited to) the following items:

We cannot agree. (1) Compensation for services in whatever form (1) Compensation for services in whatever form
paid, including, but not limited to fees, salaries, paid, including, but not limited to fees, salaries,
wages, commissions, and similar items; wages, commissions, and similar items;
b) Association dues, membership fees, and other assessments/charges are not subject to income tax, value-
added tax and withholding tax
(2) Gross income derived from the conduct of trade (2) Gross income derived from the conduct of trade
or business or the exercise of a profession; or business or the exercise of a profession;
First.  Capital is a fund or property existing at one distinct point in time while income denotes a flow of wealth
during a definite period of time. Income is gain derived and severed from capital.41 Republic Act No. 8424
(RA 8424)42 or the Tax Reform Act of 1997 was in effect when RMC No. 65-201 2 was issued on October 31, xxx xxx
2012. In defining taxable income, Section 31 of RA 8424 states:
Section 32. Gross Income. - Section 32. Gross Income.-
Section 31. Taxable Income Defined.- The term taxable income means the pertinent items of gross income
specified in this Code, less the deductions and/or personal and additional exemptions, if any, authorized for
such types of income by this Code or other special laws. (A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived
from whatever source, including (but not limited to) the following items: (A) General Definition. - Except when
otherwise provided in this Title, gross income means all income derived from whatever source, including (but
Gross income means income derived from whatever source, including compensation for services; the conduct not limited to) the following items: 
of trade or business or the exercise of a profession; dealings in propetiy; interests; rents; royalties; dividends;
annuities; prizes and winnings; pensions; and a partner's distributive share in the net income of a general
professional partnership,43 among others. (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries,
wages, commissions, and similar items;        (1) Compensation for services in whatever form paid,
including, but not limited to fees, salaries, wages, commissions, and similar items;
On December 19, 2017, Section 31 was amended by Republic Act No. 10963 (RA 10963 )44 (The TRAIN
Law). The provision now reads:
(2) Gross income derived from the conduct of trade or business or the exercise of a profession;  (2)
Gross income derived from the conduct of trade or business or the exercise of a profession; 
xxxxxx
Section 32 of RA 8424 does not include association dues, membership fees, and other assessments/charges
collected by condominium corporations as sources of gross income. The subsequent amendment under the
TRAIN Law substantially replicates the old Section 32.
Clearly, RMC No. 65-2012 expanded, if not altered, the list of taxable items in the law. RMC No. 65-2012,
therefore, is void. Besides, where the basic law and a rule or regulation are in conflict, the basic law
prevails.46
As established in Yamane, the expenditures incurred by condominium corporations on behalf of the
condominium owners are not intended to generate revenue nor equate to the cost of doing business.
In the very recent case of ANPC  v. BIR, 47 the Court pronounced that membership fees, assessment dues,
and other fees collected by recreational clubs are not subject to income tax, thus:
As corectly argued by ANPC, membership fees, assessment dues, and other fees of similar nature only
constitute contributions to and/or replenishment of the funds for the maintenance and operations of the
facilities offered by recreational clubs to their exclusive members . They represent funds "held in trust" by
these clubs to defray their operating and general costs and hence, only constitute infusion of capital.
Case law provides that in order to constitute "income," there must be realized "gain." Clearly, because of the
nature of membership fees and assessment dues as funds inherently dedicated for the maintenance,
preservation, and upkeep of the clubs' general operations and facilities, nothing is to be gained from their
collection. This stands in contrast to the tees received by recreational clubs coming from their income-
generating facilities, such as bars, restaurants, and food concessionaires, or from income-generating
activities, like the renting out of sports equipment, services, and other accommodations: In these latter
examples, regardless of the purpose of the fees' eventual use, gain is already realized fi:om the moment they
are collected because capital maintenance, preservation. or upkeep is not their pre-determined purpose. As
such, recreational clubs are generally free to use these fees for whatever purpose they desire and thus,
considered as unencumbered "fruits" coming from a business transaction.
Further, given these recreational clubs' non-profit nature, membership fees and assessment dues cannot be
considered as funds that would represent these clubs' interest or profit from any investment. In fact, these
fees are paid by the clubs' members without any expectation of any yield or gain (unlil{e in stock
subscriptions), but only for the above-stated purposes and in order to retain their membership therein.
In fine, for as long as these membership fees, assessment dues, and the like are treated as collections by
recreational clubs from their members as an inherent consequence of their membership, and are, by nature,
intended for the maintenance, preservation, and upkeep of the clubs' general operations and facilities, then
these fees cannot be classified as "the income of recreational clubs from whatever source" that are "subject to
income tax. Instead, they only form part of capital from which no income tax may be collected or
imposed. (Emphasis supplied)
Similarly, therefore, assocmtwn dues, membership fees, and other assessments/charges are not subject to
income tax because they do not constitute profit or gain. To repeat, they are collected purely for the benefit of
the condominium owners and are the incidental consequence of a condominium corporation's responsibility to
effectively oversee, maintain, or even Improve the common areas of the condominium as well as its
governance.
Second. Association dues, membership fees, and other assessments/charges do not arise from transactions
involving the sale, barter, or exchange of goods or property. Nor are they generated by the performance of
services. As such, they are not subject to value-added tax per Section 105 ofRA 8424, viz.:
Section 105. Persons Liable. -Any person who, in the course of trade or business, sells, barters, exchanges,
leases goods or properties, renders services, and any person who imports goods shall be subject to the value-
added tax (VAT) imposed in Sections 106 to 108 of this Code.
The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer,
transferee or lessee of the goods, properties or services. This rule shall likewise apply to existing contracts of
sale or lease of goods, properties or services at the time of the effectivity of Republic Act No. 7716.
The phrase "in the course of trade or business" means the regular conduct or pursuit of a commercial or an
economic activity including transactions incidental thereto, by any person regardless of whether or not the
person engaged therein is a non-stock, non-profit private organization (irrespective of the disposition of its net
income and whether or not it sells exclusively to members or their guests), or government entity.
The rule of regularity, to the contrary notwithstanding, services as defined in this Code rendered in the
Philippines by nonresident foreign persons shall be considered as being course of trade or business.
(Emphasis supplied)
The value-added tax is a burden on transactions imposed at every stage of the distribution process on the
sale, barter, exchange of goods or property, and on the performance of services, even in the absence of profit
attributable thereto, so much so that even a non-stock, non-profit organization or government entity, is liable to
pay value-added tax on the sale of goods or services.48
Section 106 ofRA 8424 imposes value-added tax on the sale of goods and properties. The term 'goods' or
'properties' shall mean all tangible and intangible objects which are capable of pecuniary estimation. These
'goods' or 'properties' include real property, intellectual property, equipment, and rights over motion picture
films.49 Section 106 ofRA 8424 likewise imposes value-added tax on transactions such as transfer of goods,
properties, profits, or inventories.50
Section 108 of RA 8424 further imposes value-added tax on sale of services and use or lease of properties. It
defines "sale or exchange of services," as follows:
The phrase 'sale or exchange of services'51 means the performance of all kinds of services in the Philippines
for others for a fee, remuneration or consideration, including those performed or rendered by construction and
service contractors; stock, real estate, commercial, customs and immigration brokers; lessors of property,
whether personal or real; warehousing services; lessors or distributors of cinematographic films; persons
engaged in milling, processing, manufacturing or repacking goods for others; proprietors, operators or keepers
of hotels, motels, rest-houses, pension houses, inns, resorts; proprietors or operators of restaurants,
refreshment parlors, cafes and other eating places, including clubs and caterers; dealers in securities; lending
investors; transportation contractors on their transport of goods or cargoes, including persons who transport
goods or cargoes for hire and other domestic common carriers by land relative to their transport of goods or
cargoes; common carriers by air and sea relative to their transport of passengers, goods or cargoes from one
place in the Philippines to another place in the Philippines; sales of electricity by generation companies,
transmission, and distribution companies; services of franchise grantees of electric utilities, telephone and
telegraph, radio and television broadcasting and all other franchise grantees except those under Section 119
of this Code and non-life insurance companies (except their crop insurances), including surety, fidelity,
indemnity and bonding companies; and similar services regardless of whether or not the performance thereof
calls for the exercise or use of the physical or mental faculties. x x x
The phrase 'sale or exchange of services' shall include the use of intellectual property, use of certain types of
equipment, supplying certain types of knowledge or information, lease of motion picture films, and use of
transmission or air time.
Both under RA 8424 (Sections 106, 107,52 and 108) and the TRAIN Law, there, too, is no mention of
association dues, membership fees, and other assessments/charges collected by condominium corporations
being subject to VAT. And rightly so. For when a condominium corporation manages, maintains, and
preserves the common areas in the building, it does so only for the benefit of the condominium owners. It
cannot be said to be engaged in trade or business, thus, the collection of association dues, membership fees,
and other assessments/charges is not a result of the regular conduct or pursuit of a commercial or an
economic activity, or any transactions incidental thereto.
Neither can it be said that a condominium corporation is rendering services to the unit owners for a fee,
remuneration or consideration. Association dues, membership fees, and other assessments/charges form part
of a pool from which a condominium corporation must draw funds in order to bear the costs for maintenance,
repair, improvement, reconstruction expenses and other administrative expenses.
Indisputably, the nature and purpose of a condominium corporation negates the carte blanche application of
our value-added tax provisions on its transactions and activities. CIR v. Magsaysay Lines, Inc.,53 stated:
Yet VAT is not a singular-minded tax on every transactional level. Its assessment bears direct relevance to the
taxpayer's role or link in the production chain. Hence, as affirmed by Section 99 of the Tax Code and its
subsequent incarnations, the tax is levied only on the sale, barter or exchange of goods or services by
persons who engage in such activities, in the course of trade or business. These transactions outside the
course of trade or business may invariably contribute to the production chain, but they do so only as a matter
of accident or incident. As the sales of goods or services do not occur within the course of trade or business,
the providers of such goods or services would hardly, if at all, have the opportunity to appropriately credit any
VAT liability as against their own accumulated VAT collections since the accumulation of output VAT arises in
the first place only through the ordinary course of trade or business. (Emphasis supplied)
Too, ANPC54 held that membership fees, assessment dues, and the like collected by recreational clubs are
not subject to value-added tax "because in collecting such fees, the club is not selling its service to the
members. Conversely, the members are not buying services from the club when dues are paid; hence, there
is no economic or commercial activity to speak of as these dues are devoted for the operations/maintenance
of the facilities of the organization. As such, there could be no 'sale, barter or exchange o.f goods or
properties, or sale of a service' to speak of, which would then be subject to VAT under the 1997 NIRC." This
principle equally applies to condominium corporations which are similarly situated with recreational clubs
insofar as membership fees, assessment dues, and other fees of similar nature collected from condominium
owners are devoted to the operations and maintenance of the facilities of the condominium. In sum, RMC No.
65-2012 illegally imposes value-added tax on association dues, membership fees, and other
assessments/charges collected and received by condominium corporations.
Third.  The withholding tax system was devised for three (3) primary reasons, i.e. --- (1) to provide taxpayers a
convenient manner to meet their probable income tax liability; (2) to ensure the collection of income tax which
can otherwise be lost or substantially reduced through failure to file the corresponding returns; and (3) to
improve the government's cash flow. This results in administrative savings, prompt and efficient collection of
taxes, prevention of delinquencies and reduction of governmental effort to collect taxes through more
complicated means and remedies.55  Succinctly put, withholding tax is intended to facilitate the collection of
income tax. And if there is no income tax, withholding tax cannot be collected.
Section 57 of RA 8424 directs that only income, be it active or passive, earned by a payor-corporation can be
subject to withholding tax, viz. :
Section 57. Withholding of Tax at Source.-
(A) Withholding of Final Tax on Certain Incomes.- Subject to rules and regulations the Secretary of Finance
may promulgate, upon the recommendation of the Commissioner, requiring the filing of income tax return by
certain income payees, the tax imposed or prescribed by Sections 24(8)(1), 24(8)(2), 24(C), 24(D)(l); 25(A)(2),
25(A)(3), 25(8), 25(C), 25(D), 25(E), 27(D)(l), 27(D)(2), 27(D)(3), 27(D)(5), 28 (A)(4), 28(A)(5), 28(A)(7)(a),
28(A)(7)( b), 28(A)(7) (c), 28(8)(1), 28(8)(2), 28(8)(3), 28(8)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and
282 of this Code on specified items of income shall be withheld by payor-corporation and/or person and paid
in the same manner and subject to the same conditions as provided in Section 58 ofthis Code.
(B) Withholding of Creditable Tax at Source.- The Secretary ofFinance may, upon the recommendation of the
Commissioner, require the withholding of a tax on the items of income payable to natural or juridical persons,
residing in the Philippines, by payor-corporation/persons as provided for by law, at the rate of not less than
one percent (l%) but not more than thirty-two percent (32%) thereof, which shall be credited against the
income tax liability of the taxpayer for the taxable year.
 x x x
Although Section 57 (B) was later amended by the TRAIN Law, it still decrees that the withholding of tax
covers only the income payable to natural or juridical persons, thus:
Sec. 57. Withholding of Tax at Source.-
(A) x x-
(B) Withholding of Creditable Tax at Source. - The Secretary of Finance may, upon the recommendation of
the Commissioner, require the withholding of a tax on the items of income payable to natural or juridical
persons, residing in the Philippines, by payor-corporation/persons as provided for by law, at the rate of not
less than one percent (1%) but not more than thirty-two percent (32%) thereof, which shall be credited against
the income tax liability of the taxpayer for the taxable year: Provided, That, beginning January 1, 2019, the
rate of withholding shall not be less than one percent (1%) but not more than fifteen percent (15%) of the
income payment.
 x x x
Yamane  aptly stated "[e]ven though the Corporation is empowered to levy assessments or dues from the unit
owners, these amounts collected are not intended for the incurrence of profit by the Corporation or its
members, but to shoulder the multitude of necessary expenses that arise from the maintenance of the
Condominium Project. "
Fourth.  Section 4 of RA 8424 empowers the BIR Commissioner to interpret tax laws and to decide tax cases:
SEC. 4. Power of the Commissioner to Interpret Tax Laws and to Decide Tax Cases- The power to interpret
the provisions of this Code and other tax laws shall be under the exclusive and original jurisdiction of the
Commissioner, subject to review by the Secretary of Finance.
The power to decide disputed assessments, refunds of internal revenue taxes, fees or other charges,
penalties imposed in relation thereto, or other matters arising under this Code or other laws or portions thereof
administered by the Bureau of Internal Revenue is vested in the Commissioner, subject to the exclusive
appellate jurisdiction of the Court of Tax Appeals.
But the BIR Commissioner cannot, in the exercise of such power, issue administrative rulings or circulars
inconsistent with the law to be implemented. Administrative issuances must not override, supplant, or modify
the law, they must remain consistent with the law intended to carry out. Surely, courts will not countenance
administrative issuances that override, instead of remaining consistent and in harmony with the law they seek
to apply and implement .56
As shown, the BIR Commissioner expanded or modified the law when she declared that association dues,
membership fees, and other assessments/charges are subject to income tax, value-added tax, and
withholding tax. In doing so, she committed grave abuse of discretion amounting to lack or excess of
jurisdiction. As to what constitutes 'grave abuse of discretion' and when a government branch, agency, or
instrumentality is deemed to have committed it, Kilusang Mayo Uno v. Aquino III57 instructs:
Grave abuse of discretion denotes a "capricious, arbitrary[,] and whimsical exercise of power. The abuse of
discretion must be patent and gross as to amount to an evasion of positive duty or to a virtual refusal to
perform a duty enjoined by law, as not to act at all in contemplation of law, or where the power is exercised in
an arbitrary and despotic manner by reason of passion or hostility."
Any act of a government branch, agency, or instrumentality that violates a statute or a treaty is grave abuse of
discretion. However, grave abuse of discretion pertains to acts of discretion exercised in areas outside an
agency's granted authority and, thus, abusing the power granted to it. Moreover, it is the agency's exercise of
its power that is examined and adjudged, not whether its application of the law is correct. (Emphasis supplied)
In sum, the BIR Commissioner is empowered to interpret our tax laws but not expand or alter them. In the
case ofRMC No. 65-2012, however, the BIR Commissioner went beyond, if not, gravely abused such
authority.
If  proper,  the First E-Bank may recover the consigned amounts, through a separate action or proceeding
The general rule is that a void law or administrative act cannot be the source of legal rights or duties. Article 7
of the Civil Code enunciates this general rule, as well as its exception: "Laws are repealed only by subsequent
ones, and their violation or non-observance shall not be excused by disuse, or custom or practice to the
contrary. When the courts declared a law to be inconsistent with the Constitution, the former shall be void and
the latter shall govern. Administrative or executive acts, orders and regulations shall be valid only when they
are not contrary to the laws or the Constitution. "58 Jurisprudence is replete with instances when this Court
had directed the refund of taxes that were paid under invalid tax measures, thus:
1) In Icard v. The City Council of Baguio , 59 this Court held that the City of Baguio's ordinances,
namely, Ordinance No. 6 -V (which imposed an amusement tax of 0.20 for each person entering a
night club) and Ordinance No. 11 -V (which provides for a property tax on motor vehicles) were ultra
vires. As a consequence, this Court ordered the City of Baguio to refund to petitioner-appellee in that
case the sum of P254.80 which he paid as amusement tax.
2) In Matalin Coconut Co., Inc. v. The Municipal Council of Malabang 60 the Court agreed with the
trial court's finding that the Municipality of Malabang's Municipal Ordinance No. 45-66, imposing a
"police inspection fee" of P0.30 per sack of cassava starch or flour was an invalid act of taxation. The
trial court's directive to the municipal treasurer "to refund to the petitioner the payments it made
under the said ordinance from September 27, 1966 to May 2, 1967, amounting to P25,500.00, as
well as all payments made subsequently thereafter" was likewise affirmed by this Court.
3) In Cagayan Electric Power and Light, Co. Inc. v. City of Cagayan de Oro , 61 this Court directed
the City of Cagayan de Oro to refund to CEPALCO the tax payments made by the latter "on the lease
or rental of electric and/or telecommunication posts, poles or towers by pole owners to other pole
users at ten percent (10%) of the annual rental income derived from such lease or rental" after the
city's tax Ordinance No. 9503-2005 was declared invalid.
Petitioner resorted to judicial consignation of its alleged tax payments in the court, thus, reckons with the
requirements of judicial consignation, viz.: (1) a debt due; (2) the creditor to whom tender of payment was
made refused without just cause to accept the payment, or the creditor was absent, unknown or incapacitated,
or several persons claimed the same right to collect, or the title of the obligation was lost; (3) the person
interested in the performance of the obligation was given notice before consignation was made; (4) the
amount was placed at the disposal of the court; and (5) the person interested in the performance of the
obligation was given notice after the consignation was made.62
Here, it is imperative to determine whether the First E-Bank actually complied with the requirements for
judicial consignation. This is a question of fact which by this Court, not being a trial court cannot pass upon.
The trial court, therefore, thus correctly held that the First E-Bank may initiate the appropriate motion for the
release of the consignated funds, upon finality of the judicial determination on the validity ofRMC No. 65-2012
and only after it has determined the presence of the requirements for judicial consignation.

A final word

RMC No. 65-2012 is invalid for ordaining that "gross receipts of condominium corporations including
association dues, membership fees, and other assessments/charges are subject to VAT, income tax and
income payments made to it are subject to applicable withholding taxes." A law will not be construed as
imposing a tax unless it does so clearly and expressly. In case of doubt, tax laws must be construed strictly United States Supreme Court
against the government and in favor of the taxpayer.63 Taxes, as burdens that must be endured by the
taxpayer, should not be presumed to go beyond what the law expressly and clearly declares.64 EISNER v. MACOMBER(1920)

ACCORDINGLY, the Court RESOLVES: No. 318

1) To REVERSE and SET ASIDE the assailed Resolutions dated June 26, 2014 and November 27, Argued: April 16, 1919Decided: March 08, 1920
2014 of the Court of Appeals in CA-G.R. CV No. 102266;

[252 U.S. 189, 190]   Mr. Assistant Attorney General Frierson, for plaintiff in error.
2) To DENY the Petition for Review dated February 17,2015 in G.R. No. 215801 and the Special
Civil Action for Certiorari dated February 12, 2015 in G.R. No. 218924; and
[252 U.S. 189, 194]   Messrs. Charles E. Hughes and George Welwood Murray, both of New York City, for
defendant in error.
3) To AFFIRM the Resolution dated September 5, 2013 and Order dated December 18, 2013 of the
Regional Trial Court, Branch 146, Makati City in Special Civil Action No. 12-1236.
[252 U.S. 189, 199]  
SO ORDERED.
Mr. Justice PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power to
tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith
against profits accumulated by the corporation since March 1, 1913.

It arises under the Revenue Act of September 8, 1916 (39 Stat. 756 et seq., c. 463 [Comp. St. 6336a et seq.]),
which, in our opinion ( notwithstanding a contention of the government that will be [252 U.S. 189,
200]   noticed), plainly evinces the purpose of Congress to tax stock dividends as income. 1  

The facts, in outline, are as follows:

On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of an authorized
capital stock of $100,000, 000, had shares of stock outstanding, par value $100 each, amounting in round
figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and
business and required for the purposes of the corporation, amounting to about $45,000,000, of which about
$20,000,000 had been earned prior to March 1, 1913, the balance thereafter. In January, 1916, in order to
readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a
stock dividend of 50 per cent. of the outstanding stock, and to transfer from surplus account to capital stock
account an amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to
the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it
and divided among the stockholders.
Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1,100
additional [252 U.S. 189, 201]   shares, of which 18.07 per cent., or 198.77 shares, par value $19,877, were
treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to
pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed
income of $ 19,877 because of the new shares; and an appeal to the Commissioner of Internal Revenue
having been disallowed, she brought action against the Collector to recover the tax. In her complaint she
alleged the above facts, and contended that in imposing such a tax the Revenue Act of 1916 violated article 1,
2, cl. 3, and article 1, 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned
according to population, and that the stock dividend was not income within the meaning of the Sixteenth
Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner, 245
U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254; and, defendant having failed to plead further, final judgment
went against him. To review it, the present writ of error is prosecuted.
The case was argued at the last term, and reargued at the present term, both orally and by additional briefs.
We are constrained to hold that the judgment of the District Court must be affirmed: First, because the
question at issue is controlled by Towne v. Eisner, supra; secondly, because a re-examination of the question
with the additional light thrown upon it by elaborate arguments, has confirmed the view that the underlying
ground of that decision is sound, that it disposes of the question here presented, and that other fundamental
considerations lead to the same result.
In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior to
January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913 (38 Stat. 114, 166, c.
16 ), which provided (section B, p. 167) that net income should include 'dividends,' and also 'gains or profits
and income derived [252 U.S. 189, 202]   from any source whatever.' Suit having been brought by a
stockholder to recover the tax assessed against him by reason of the dividend, the District Court sustained a
demurrer to the complaint. 242 Fed. 702. The court treated the construction of the act as inseparable from the
interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158
U.S. 601 , 15 Sup. Ct. 912, and quoted the Amendment, proceeded very properly to say (242 Fed. 704):
'It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not,
even though Congress expressly declared it to be taxable as income, unless it is in fact income.'
It declined, however, to accede to the contention that in Gibbons v. Mahon, 136 U.S. 549 , 10 Sup. Ct. 1057,
'stock dividends' had received a definition sufficiently clear to be controlling, treated the language of this court
in that case as obiter dictum in respect of the matter then before it (242 Fed. 706), and examined the question
as res nova, with the result stated. When the case came here, after overruling a motion to dismiss made by
the government upon the ground that the only question involved was the construction of the statute and not its
constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon
consideration of the essential nature of a stock dividend disregarding the fact that the one in question was
based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we
rejected the reasoning of the District Court, saying ( 245 U.S. 426 , 38 Sup. Ct. 159, L. R. A. 1918D, 254):
'Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend
was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and
remainderman. What was said by this court upon the latter question is equally true for the former. 'A stock
dividend really takes nothing from the property of the corporation, and adds nothing to the [252 U.S. 189,
203]   interests of the shareholders. Its property is not diminished, and their interests are not increased. ... The
proportional interest of each shareholder remains the same. The only change is in the evidence which
represents that interest, the new shares and the original shares together representing the same proportional
interest that the original shares represented before the issue of the new ones.' Gibbons v. Mahon, 136 U.S.
549, 559 , 560 S. [10 Sup. Ct. 1057]. In short, the corporation is no poorer and the stockholder is no richer
than they were before. Logan County v. United States, 169 U.S. 255 , 261 [18 Sup. Ct. 361]. If the plaintiff
gained any small advantage by the change, it certainly was not an advantage of $417,450, the sum upon
which he was taxed. ... What has happened is that the plaintiff's old certificates have been split up in effect
and have diminished in value to the extent of the value of the new.'
This language aptly answered not only the reasoning of the District Court but the argument of the Solicitor
General in this court, which discussed the essential nature of a stock dividend. And if, for the reasons thus
expressed, such a dividend is not to be regarded as 'income' or 'dividends' within the meaning of the act of
1913, we are unable to see how it can be brought within the meaning of 'incomes' in the Sixteenth
Amendment; it being very clear that Congress intended in that act to exert its power to the extent permitted by
the amendment. In Towne v. Eisner it was not contended that any construction of the statute could make it
narrower than the constitutional grant; rather the contrary.
The fact that the dividend was charged against profits earned before the act of 1913 took effect, even before
the amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that
case. Not only so, but had we considered that a stock dividend constituted income in any true sense, it would
have been held taxable under the act of 1913 notwithstanding it was [252 U.S. 189, 204]   based upon profits
earned before the amendment. We ruled at the same term, in Lynch v. Hornby, 247 U.S. 339 , 38 Sup. Ct.
543, that a cash dividend extraordinary in amount, and in Peabody v. Eisner, 247 U.S. 347 , 38 Sup. Ct. 546,
that a dividend paid in stock of another company, were taxable as income although based upon earnings that
accrued before adoption of the amendment. In the former case, concerning 'corporate profits that
accumulated before the act took effect,' we declared ( 247 U.S. 343, 344 , 38 S. Sup. Ct. 543, 545 [62 L. Ed.
1149]):
'Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only
if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends
declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when
dividends are declared out of a pre-existing surplus. ... Congress was at liberty under the amendment to tax
as income, without apportionment, everything that became income, in the ordinary sense of the word, after the
adoption of the amendment, including dividends received in the ordinary course by a stockholder from a
corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere
realization in possession of an inchoate and contingent interest that the stockholder had in a surplus of
corporate assets previously existing.'
In Peabody v. Eisner, 247 U.S. 349, 350 , 38 S. Sup. Ct. 546, 547 (62 L. Ed. 1152), we observed that the
decision of the District Court in Towne v. Eisner had been reversed 'only upon the ground that it related to a
stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest
of the shareholder, but merely changed the evidence which represented that interest,' and we distinguished
the Peabody Case from the Towne Case upon the ground that 'the dividend of Baltimore & Ohio shares was
not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific.'
Therefore Towne v. Eisner cannot be regarded as turning [252 U.S. 189, 205]   upon the point that the surplus
accrued to the company before the act took effect and before adoption of the amendment. And what we have
quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis
for the conclusion reached. We adhere to the view then expressed, and might rest the present case there, not
because that case in terms decided the constitutional question, for it did not, but because the conclusion there
reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in
any true sense.
Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue Act of 1916
declared (39 Stat. 757 [Comp. St . 6336b]) that a 'stock dividend shall be considered income, to the amount of
its cash value,' we will deal at length with the constitutional question, incidentally testing the soundness of our
previous conclusion.
The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution
and the effect attributed to them before the amendment was adopted. In Pollock v. Farmers' Loan & Trust Co.,
158 U.S. 601 , 15 Sup. Ct. 912, under the Act of August 27, 1894 (28 Stat. 509, 553, c. 349, 27), it was held
that taxes upon rents and profits of real estate and upon returns from investments of personal property were in
effect direct taxes upon the property from which such income arose, imposed by reason of ownership; and
that Congress could not impose such taxes without apportioning them among the states according to
population, as required by article 1, 2, cl. 3, and section 9, cl. 4, of the original Constitution.
Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined,
the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished:
'The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without
apportionment among [252 U.S. 189, 206]   the several states, and without regard to any census or
enumeration.'
As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity
which otherwise might exist for an apportionment among the states of taxes laid on income. Brushaber v.
Union Pacific R. R. Co., 240 U.S. 1 , 17-19, 36 Sup. Ct. 236, Ann. Cas. 1917B, 713, L. R. A. 1917D, 414;
Stanton v. Baltic Mining Co., 240 U.S. 103 , 112 et seq., 36 Sup. Ct. 278; Peck & Co. v. Lowe, 247 U.S. 165,
172 , 173 S., 38 Sup. Ct. 432.
A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not
be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of
the Constitution that require an apportionment according to population for direct taxes upon property, real and
personal. This limitation still has an appropriate and important function, and is not to be overridden by
Congress or disregarded by the courts.
In order, therefore, that the clauses cited from article 1 of the Constitution may have proper force and effect,
save only as modified by the amendment, and that the latter also may have proper effect, it becomes essential
to distinguish between what is and what is not 'income,' as the term is there used, and to apply the distinction,
as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it
may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives
its power to legislate, and within whose limitations alone that power can be lawfully exercised.
The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being
likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied
from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present
purpose we require only a clear definition of the term 'income,' [252 U.S. 189, 207]   as used in common
speech, in order to determine its meaning in the amendment, and, having formed also a correct judgment as
to the nature of a stock dividend, we shall find it easy to decide the matter at issue.
After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's Internat. Dict.; Century
Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act
of 1909 (Stratton's Independence v. Howbert, 231 U.S. 399, 415 , 34 S. Sup. Ct. 136, 140 [58 L. Ed. 285];
Doyle v. Mitchell Bros. Co., 247 U.S. 179, 185 , 38 S. Sup. Ct. 467, 469 [62 L. Ed. 1054]), 'Income may be
defined as the gain derived from capital, from labor, or from both combined,' provided it be understood to
include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle Case,
247 U.S. 183, 185 , 38 S. Sup. Ct. 467, 469 (62 L. Ed. 1054).
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution
of the present controversy. The government, although basing its argument upon the definition as quoted,
placed chief emphasis upon the word 'gain,' which was extended to include a variety of meanings; while the
significance of the next three words was either overlooked or misconceived. 'Derived-from- capital'; 'the gain-
derived-from-capital,' etc. Here we have the essential matter: not a gain accruing to capital; not a growth or
increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from
the property, severed from the capital, however invested or employed, and coming in, being 'derived'-that is,
received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal- that is income
derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment-'incomes, from whatever
source derived'-the essential thought being expressed [252 U.S. 189, 208]   with a conciseness and lucidity
entirely in harmony with the form and style of the Constitution.
Can a stock dividend, considering its essential character, be brought within the definition? To answer this,
regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course, to a
corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into
shares to which a nominal or par value is attributed.
Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence
of it. They state the number of shares to which he is entitled and indicate their par value and how the stock
may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the
enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the
property and business of the company devoted during the corporate existence to attainment of the common
objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and
when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any,
remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw
any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any
part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest
of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The
stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned;
but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the enterprise,
and looking only to dividends for his return. If he desires to dissociate himself [252 U.S. 189, 209]   from the
company he can do so only by disposing of his stock.
For bookeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the
aggregate par value of their stock, evidenced by a 'capital stock account.' If profits have been made and not
divided they create additional bookkeeping liabilities under the head of 'profit and loss,' 'undivided profits,'
'surplus account,' or the like. None of these, however, gives to the stockholders as a body, much less to any
one of them, either a claim against the going concern for any particular sum of money, or a right to any
particular portion of the assets or any share in them unless or until the directors conclude that dividends shall
be made and a part of the company's assets segregated from the common fund for the purpose. The dividend
normally is payable in money, under exceptional circumstances in some other divisible property; and when so
paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company)
does the stockholder realize a profit or gain which becomes his separate property, and thus derive income
from the capital that he or his predecessor has invested.
In the present case, the corporation had surplus and undivided profits invested in plant, property, and
business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to
outstanding capital stock of $50,000,000. In this the case is not extraordinary. The profits of a corporation, as
they appear upon the balance sheet at the end of the year, need not be in the form of money on hand in
excess of what is required to meet current liabilities and finance current operations of the company. Often,
especially in a growing business, only a part, sometimes a small part, of the year's profits is in property
capable of division; the remainder having been absorbed in the acquisition of increased plant, [252 U.S. 189,
210]   quipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When only a
part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or
surplus, or some other account having like significance. If thereafter the company finds itself in funds beyond
current needs it may declare dividends out of such surplus or undivided profits; otherwise it may go on for
years conducting a successful business, but requiring more and more working capital because of the
extension of its operations, and therefore unable to declare dividends approximating the amount of its profits.
Thus the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock.
This may be adjusted upon the books in the mode adopted in the case at bar-by declaring a 'stock dividend.'
This, however, is no more than a book adjustment, in essence not a dividend but rather the opposite; no part
of the assets of the company is separated from the common fund, nothing distributed except paper certificates
that evidence an antecedent increase in the value of the stockholder's capital interest resulting from an
accumulation of profits by the company, but profits so far absorbed in the business as to render it
impracticable to separate them for withdrawal and distribution. In order to make the adjustment, a charge is
made against surplus account with corresponding credit to capital stock account, equal to the proposed
'dividend'; the new stock is issued against this and the certificates delivered to the existing stockholders in
proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate
assets of the corporation or its outstanding liabilities; it affects only the form, not the essence, of the 'liability'
acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one
side of the balance sheet only, increasing 'capital stock' at the expense of [252 U.S. 189, 211]   'SURPLUS'; IT
DOES NOT ALTER THE PRE-EXisting proportionate interest of any stockholder or increase the intrinsic value
of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates
simply increase the number of the shares, with consequent dilution of the value of each share.
A 'stock dividend' shows that the company's accumulated profits have been capitalized, instead of distributed
to the stockholders or retained as surplus available for distribution in money or in kind should opportunity offer.
Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that
the fund represented by the new stock has been transferred from surplus to capital, and no longer is available
for actual distribution.
The essential and controlling fact is that the stockholder has received nothing out of the company's assets for
his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever
accretions and accumulations have resulted from employment of his money and that of the other stockholders
in the business of the company, still remains the property of the company, and subject to business risks which
may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and
not to form, he has recived nothing that answers the definition of income within the meaning of the Sixteenth
Amendment.
Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside
the question whether in a particular case a stock dividend may be authorized by the local law governing the
corporation, or whether the capitalization of profits may be the result of correct judgment and proper business
policy on the part of its management, and a due regard for the interests of the stockholders. And we are
considering the taxability of bona fide stock dividends only. [252 U.S. 189, 212]   We are clear that not only
does a stock dividend really take nothing from the property of the corporation and add nothing to that of the
shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the
shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or
received any income in the transaction.
It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he may, if he can
find a buyer. It is equally true that if he does sell, and in doing so realizes a profit, such profit, like any other, is
income, and so far as it may have arisen since the Sixteenth Amendment is taxable by Congress without
apportionment. The same would be true were he to sell some of his original shares at a profit. But if a
shareholder sells dividend stock he necessarily disposes of a part of his capital interest, just as if he should
sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the
same proportion of future dividends as before the sale. His part in the control of the company likewise is
diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should
receive in common with other stockholders a 50 per cent. stock dividend, and should sell his part, he thereby
would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six- tenths of the
total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power
would befall a minority holder should he sell dividend stock; it being in the nature of things impossible for one
to dispose of any part of such an issue without a proportionate disturbance of the distribution of the entire
capital stock, and a like diminution of the seller's comparative voting power-that 'right preservative of rights' in
the control of a corporation. [252 U.S. 189, 213]   Yet, without selling, the shareholder, unless possessed of
other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more
clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration
that in the nature of things it requires conversion of capital in order to pay the tax.
Throughout the argument of the government, in a variety of forms, runs the fundamental error already
mentioned-a failure to appraise correctly the force of the term 'income' as used in the Sixteenth Amendment,
or at least to give practical effect to it. Thus the government contends that the tax 'is levied on income derived
from corporate earnings,' when in truth the stockholder has 'derived' nothing except paper certificates which,
so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be
laid when earnings 'are received by the stockholder,' whereas he has received none; that the profits are
'distributed by means of a stock dividend,' although a stock dividend distributes no profits; that under the act of
1916 'the tax is on the stockholder's share in corporate earnings,' when in truth a stockholder has no such
share, and receives none in a stock dividend; that 'the profits are segregated from his former capital, and he
has a separate certificate representing his invested profits or gains,' whereas there has been no segregation
of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old,
are alike in what they represent-a capital interest in the entire concerns of the corporation.
We have no doubt of the power or duty of a court to look through the form of the corporation and determine
the question of the stockholder's right, in order to ascertain whether he has received income taxable by
Congress without apportionment. But, looking through the form, [252 U.S. 189, 214]   we cannot disregard the
essential truth disclosed, ignore the substantial difference between corporation and stockholder, treat the
entire organization as unreal, look upon stockholders as partners, when they are not such, treat them as
having in equity a right to a partition of the corporate assets, when they have none, and indulge the fiction that
they have received and realized a share of the profits of the company which in truth they have neither
received nor realized. We must treat the corporation as a substantial entity separate from the stockholder, not
only because such is the practical fact but because it is only by recognizing such separateness that any
dividend-even one paid in money or property-can be regarded as income of the stockholder. Did we regard
corporation and stockholders as altogether identical, there would be no income except as the corporation
acquired it; and while this would be taxable against the corporation as income under appropriate provisions of
law, the individual stockholders could not be separately and additionally taxed with respect to their several
shares even when divided, since if there were entire identity between them and the company they could not
be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket
to another.
Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the government
nevertheless contends extent to which the gains accumulated by the extend to which the gains accumulated
by the corporation have made him the richer. There are two insuperable difficulties with this: In the first place,
it would depend upon how long he had held the stock whether the stock dividend indicated the extent to which
he had been enriched by the operations of the company; unless he had held it throughout such operations the
measure would not hold true. Secondly, and more important for present purposes, enrichment through
increase in value [252 U.S. 189, 215]   of capital investment is not income in any proper meaning of the term.
The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon
sales before and after the stock dividend, tending to show that the receipt of the additional shares did not
substantially change the market value of her entire holdings. This tends to show that in this instance market
quotations reflected intrinsic values-a thing they do not always do. But we regard the market prices of the
securities as an unsafe criterion in an inquiry such as the present, when the question must be, not what will
the thing sell for, but what is it in truth and in essence.
It is said there is no difference in principle between a simple stock dividend and a case where stockholders
use money received as cash dividends to purchase additional stock contemporaneously issued by the
corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his
own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as
the one we have under consideration, where nothing of value is taken from the company's assets and
transferred to the individual ownership of the several stockholders and thereby subjected to their disposal.
The government's reliance upon the supposed analogy between a dividend of the corporation's own shares
and one made by distributing shares owned by it in the stock of another company, calls for no comment
beyond the statement that the latter distributes assets of the company among the shareholders while the
former does not, and for no citation of authority except Peabody v. Eisner, 247 U.S. 347, 349 , 350 S., 38 Sup.
Ct. 546.
Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the
government. [252 U.S. 189, 216]   Swan Brewery Co., Ltd. v. Rex, [252 U.S. 189, 1914]   A. C. 231, arose
under the Dividend Duties Act of Western Australia, which provided that 'dividend' should include 'every
dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or
directors of any company,' except, etc. There was a stock dividend, the new shares being allotted among the
shareholders pro rata; and the question was whether this was a distribution of a dividend within the meaning
of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that,
although 'in ordinary language the new shares would not be called a dividend, nor would the allotment of them
be a distribution of a dividend,' yet, within the meaning of the act, such new shares were an 'advantage' to the
recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented
merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of
this court when acting under a duty to test an act of Congress by the limitations of a written Constitution
having superior force.
In Tax Commissioner v. Putnam (1917) 227 Mass. 522, 116 N. E. 904, L. R. A. 1917F, 806, it was held that
the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the Legislature full
power to tax incomes, 'must be interpreted as including every item which by any reasonable understanding
can fairly be regarded as income' (227 Mass. 526, 531, 116 N. E. 904, 907 [L. R. A. 1917F, 806]), and that
under it a stock dividend was taxable as income; the court saying (227 Mass. 535, 116 N. E. 911, L. R. A.
1917F, 806):
'In essence the thing which has been done is to distribute a symbol representing an accumulation of profits,
which instead of being paid out in cash is invested in the business, thus augmenting its durable assets. In this
aspect of the case the substance of the transaction is no different from what it would be if a cash dividend had
been declared with the privilege of subscription to an equivalent amount of new shares.' [252 U.S. 189,
217]   We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing
provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital
accretion for its opposite; while a case where money is paid into the hand of the stockholder with an option to
buy new shares with it, followed by acceptance of the option, was regarded as identical in substance with a
case where the stockholder receives no money and has no option. The Massachusetts court was not under an
obligation, like the one which binds us, of applying a constitutional amendment in the light of other
constitutional provisions that stand in the way of extending it by construction.
Upon the second argument, the government, recognizing the force of the decision in Towne v. Eisner, supra,
and virtually abandoning the contention that a stock dividend increases the interest of the stockholder or
otherwise enriches him, insisted as an alternative that by the true construction of the act of 1916 the tax is
imposed, not upon the stock dividend, but rather upon the stockholder's share of the undivided profits
previously accumulated by the corporation; the tax being levied as a matter of convenience at the time such
profits become manifest through the stock dividend. If so construed, would the act be constitutional?
That Congress has power to tax shareholders upon their property interests in the stock of corporations is
beyond question, and that such interests might be valued in view of the condition of the company, including its
accumulated and undivided profits, is equally clear. But that this would be taxation of property because of
ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond
peradventure by previous decisions of this court.
The government relies upon Collector v. Hubbard (1870) [252 U.S. 189, 218]   12 Wall. 1, (20 L. Ed. 272),
which arose under section 117 of the Act of June 30, 1864 (13 Stat. 223, 282, c. 173), providing that--
'The gains and profits of all companies, whether incorporated or partnership, other than the companies
specified in that section, shall be included in estimating the annual gains, profits, or income of any person,
entitled to the same, whether divided or otherwise.'
The court held an individual taxable upon his proportion of the earnings of a corporation although not declared
as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for
certain purposes had no title prior to dividend declared, the court nevertheless said (12 Wall. 18):
'Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its
incidents, and that among those incidents is the right to receive all future dividends, that is, his proportional
share of all profits not then divided. Profits are incident to the share to which the owner at once becomes
entitled provided he remains a member of the corporation until a dividend is made. Regarded as an incident to
the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift,
or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being
manufactured are investments in which the stockholders are interested, and when such profits are actually
appropriated to the payment of the debts of the corporation they serve to increase the market value of the
shares, whether held by the original subscribers or by assignees.'
In so far as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in
accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers'
Loan & Trust Co., 158 U.S. 601, 627 , 628 S., 637, 15 Sup. Ct. 912. Conceding Collector v. Hubbard was
inconsistent with the doctrine of that case, because it sustained a direct tax upon property not
apportioned [252 U.S. 189, 219]   AMONG THE STATES, THE GOVERNMENT NEVERTHEless insists that
the sixteenth Amendment removed this obstacle, so that now the Hubbard Case is authority for the power of
Congress to levy a tax on the stockholder's share in the accumulated profits of the corporation even before
division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the
amendment applies to income only, and what is called the stockholder's share in the accumulated profits of
the company is capital, not income. As we have pointed out, a stockholder has no individual share in
accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared.
Thus, from every point of view we are brought irresistibly to the conclusion that neither under the Sixteenth
Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made
lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act
of 1916, in so far as it imposes a tax upon the stockholder because of such dividend, contravenes the
provisions of article 1, 2, cl. 3, and article 1, 9, cl. 4, of the Constitution, and to this extent is invalid,
notwithstanding the Sixteenth Amendment.
Judgment affirmed.
Mr. Justice HOLMES, dissenting.
I think that Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254, was right in its reasoning
and result and that on sound principles the stock dividend was not income. But it was clearly intimated in that
case that the construction of the statute then before the Court might be different from that of the Constitution.
245 U.S. 425 , 38 Sup. Ct. 158, L. R. A. 1918D, 254. I think that the word 'incomes' in the Sixteenth
Amendment should be read in [252 U.S. 189, 220]   'a sense most obvious to the common understanding at
the time of its adoption.' Bishop v. State, 149 Ind. 223, 230, 48 N. E. 1038, 1040, 39 L. R. A. 278, 63 Am. St.
Rep. 270; State v. Butler, 70 Fla. 102, 133, 69 South. 771. For it was for public adoption that it was proposed.
McCulloch v. Maryland, 4 Wheat. 316, 407. The known purpose of this Amendment was to get rid of nice
questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose
when they voted for it that they put a question like the present to rest. I am of opinion that the Amendment
justifies the tax. See Tax Commissioner v. Putnam, 227 Mass. 522, 532, 533, 116 N. E. 904, L. R. A. 1917F,
806.
Mr. Justice DAY concurs in this opinion.
Mr. Justice BRANDEIS delivered the following [dissenting] opinion:
Financiers, with the aid of lawyers, devised long ago two different methods by which a corporation can,
without increasing its indebtedness, keep for corporate purposes accumulated profits, and yet, in effect,
distribute these profits among its stockholders. One method is a simple one. The capital stock is increased;
the new stock is paid up with the accumulated profits; and the new shares of paid-up stock are then
distributed among the stockholders pro rata as a dividend. If the stockholder prefers ready money to
increasing his holding of the stock in the company, he sells the new stock received as a dividend. The other
method is slightly more complicated. .arrangements are made for an increase of stock to be offered to
stockholders pro rata at par, and, at the same time, for the payment of a cash dividend equal to the amount
which the stockholder will be required to pay to [252 U.S. 189, 221]   the company, if he avails himself of the
right to subscribe for his pro rata of the new stock. If the stockholder takes the new stock, as is expected, he
may endorse the dividend check received to the corporation and thus pay for the new stock. In order to ensure
that all the new stock so offered will be taken, the price at which it is offered is fixed far below what it is
believed will be its market value. If the stockholder prefers ready money to an increase of his holdings of
stock, he may sell his right to take new stock pro rata, which is evidenced by an assignable instrument. In that
event the purchaser of the rights repays to the corporation, as the subscription price of the new stock, an
amount equal to that which it had paid as a chsh dividend to the stockholder.
Both of these methods of retaining accumulated profits while in effect distributing them as a dividend had been
in common use in the United States for many years prior to the adoption of the Sixteenth Amendment. They
were recognized equivalents. Whether a particular corporation employed one or the other method was
determined sometimes by requirements of the law under which the corporation was organized; sometimes it
was determined by preferences of the individual officials of the corporation; and sometimes by stock market
conditions. Whichever method was employed the resultant distribution of the new stock was commonly
referred to as a stock dividend. How these two methods have been employed may be illustrated by the action
in this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial Chronicle)
of some of the Standard Oil companies, since the disintegration pursuant to the decision of this court in 1911.
Standard Oil Co. v. United States, 221 U.S. 1 , 31 Sup. Ct. 502, 34 L. R. A. (N. S.) 834, Ann. Cas. 1912D,
734.
(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911, $1,000,000 capital
stock (all common), and a large surplus. On May 15, [252 U.S. 189, 222]   1912, it increased its capital stock
to $30,000,000, and paid a simple stock dividend of 2,900 per cent. in stock. 2   and that the financial results to the corporation and to the stockholders of the two methods are substantially
(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911, $600,000 capital
stock (all common), and a substantial surplus. On April 15, 1912, it paid a simple stock dividend of 33 1/3 per
cent., increasing the outstanding capital to $800,000. During the calendar year 1912 it paid cash dividends
aggregating 20 per cent., but it earned considerably more, and had at the close of the year again a substantial
surplus. On June 20, 1913, it declared a further stock dividend of 25 per cent., thus increasing the capital to
$1,000,000.3
(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913, $1,000,000
capital stock (all common) and $3,701, 710 surplus. Of this surplus $902,457 had been earned during the
calendar year 1913, the net profits of that year having been $1,002,457 and the dividends paid only $100,000
(10 per cent.). On December 22, 1913, a cash dividend of $200 per share was declared payable on February
14, 1914, to stockholders of record January 31, 1914, and these stockholders were offered the right to
subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. The
outstanding stock was thus increased to $3,000,000. During the calendar years 1914, 1915, and 1916,
quarterly dividends were paid on this stock at an annual rate of between 15 per cent. and 20 per cent., but the
company's surplus increased by $2,347,614, so that on December 31, 1916, it had a large surplus over its
$3,000,000 capital stock. On December 15, 1916, the company issued a circular to the stockholders, saying:
'The company's business for this year has shown a [252 U.S. 189, 223]   very good increase in volume and a
proportionate increase in profits, and it is estimated that by January 1, 1917, the company will have a surplus
of over $4,000,000. The board feels justified in stating that if the proposition to increase the capital stock is
acted on favorably, it will be proper in the near future to declare a cash dividend of 100 per cent. and to allow
the stockholders the privilege pro rata according to their holdings, to purchase the new stock at par, the plan
being to allow the stockholders, if they desire, to use their cash dividend to pay for the new stock.'
The increase of stock was voted. The company then paid a cash dividend of 100 per cent., payable May 1,
1917, again offering to such stockholders the right to subscribe for an equal amount of new stock at par and to
apply the cash dividend in payment therefor.
Moody's Manual, describing the transaction with exactness, says first that the stock was increased from
$3,000,000 to $6,000,000, 'a cash dividend of 100 per cent., payable May 1, 1917, being exchanged for one
share of new stock, the equivalent of a 100 per cent. stock dividend.' But later in the report giving, as
customary in the Manual the dividend record of the company, the Manual says: 'A stock dividend of 200 per
cent. was paid February 14, 1914, and one of 100 per cent. on May 1, 1197.' And in reporting specifically the
income account of the company for a series of years ending December 31, covering net profits, dividends paid
and surplus for the year, it gives, as the aggregate of dividends for the year 1917, $ 660,000 (which was the
aggregate paid on the quarterly cash dividend-5 per cent. January and April; 6 per cent. July and October),
and adds in a note: 'In addition a stock dividend of 100 per cent. was paid during the year.' 4 The Wall Street
Journal of [252 U.S. 189, 224]   May 2, 1917, p. 2, quotes the 1917 'high' price for Standard Oil of Kentucky as
'375 ex stock dividend.'
It thus appears that among financiers and investors the distribution of the stock, by whichever method
effected, is called a stock dividend; that the two methods by which accumulated profits are legally retained for
corporate purposes and at the same time distributed as dividends are recognized by them to be equivalents;
the same-unless a difference results from the application of the federal Income Tax Law.
Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the Standard Oil
Company (of California), a corporation organized under the laws of California and having its principal place of
business in that state. During that year she received from the company a stock dividend representing profits
earned since March 1, 1913. The dividend was paid by direct issue of the stock to her according to the simple
method described above, pursued also by the Indiana and Nebraska companies. In 1917 she was taxed
under the federal law on the stock dividend so received at its par value of $100 a share, as income received
during the year 1916. Such a stock dividend is income, as distinguished from capital, both under the law of
New York and under the law of California, because in both states every dividend representing profits is
deemed to be income, whether paid in cash or in stock. It had been so held in New York, where the question
arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N. Y. 137, 64 N. E.
796; Matter of Osborne, 209 N. Y. 450, 103 N. E. 723, 823, 50 L. R. A. ( N. S.) 510, Ann.Cas. 1915A, 298;
and also, where the question arose in matters of taxation, People v. Glynn, [252 U.S. 189, 225]   130 App. Div.
332, 114 N. Y. Supp. 460; Id. 198 N. Y. 605, 92 N. E. 1097. It has been so held in California, where the
question appears to have arisen only in controversies between life tenant and remainderman. Estate of Duffill,
183 Pac. 337.
It is conceded that if the stock dividend paid to Mrs. Macomber had been made by the more complicated
method pursued by the Standard Oil Company of Kentucky; that is, issuing rights to take new stock pro rata
and paying to each stockholder simultaneously a dividend in cash sufficient in amount to enable him to pay for
this pro rata of new stock to be purchased-the dividend so paid to him would have been taxable as income,
whether he retained the cash or whether he returned it to the corporation in payment for his pro rata of new
stock. But it is contended that, because the simple method was adopted of having the new stock issued direct
to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she retained it or
converted it into cash by sale. If such a different result can flow merely from the difference in the method
pursued, it must be because Congress is without power to tax as income of the stockholder either the stock
received under the latter method or the proceeds of its sale; for Congress has, by the provisions in the
Revenue Act of 1916, expressly declared its purpose to make stock dividends, by whichever method paid,
taxable as income.
The Sixteenth Amendment, proclaimed February 25, 1913, declares:
'The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without
apportionment among the several states, and without regard to any census or enumeration.'
The Revenue Act of September 8, 1916, c. 463, 2a, 39 Stat. 756, 757, provided:
'That the term 'dividends' as used in this title shall [252 U.S. 189, 226]   be held to mean any distribution made
or ordered to be made by a corporation, ... out of its earnings or profits accrued since March first, nineteen
hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, ... which
stock dividend shall be considered income, to the amount of its cash value.'
Hitherto powers conferred upon Congress by the Constitution have been liberally construed, and have been
held to extend to every means appropriate to attain the end sought. In determining the scope of the power the
substance of the transaction, not its form has been regarded. Martin v. Hunter, 1 Wheat, 304, 326; McCulloch
v. Maryland, 4 Wheat. 316, 407, 415; Brown v. Maryland, 12 Wheat. 419, 446; Craig v. Missouri, 4 Pet. 410,
433; Jarrolt v. Moberly, 103 U.S. 580, 585 , 587 S.; Legal Tender Case, 110 U.S. 421, 444 , 4 S. Sup. Ct. 122;
Lithograph Co. v. Sarony, 111 U.S. 53, 58 , 4 S. Sup. Ct. 279; United States v. Realty Co., 163 U.S. 427, 440 ,
441 S., 442, 16 Sup. Ct. 1120; South Carolina v. United States, 199 U.S. 437, 448 , 449 S., 26 Sup. Ct. 110, 4
Ann. Cas. 737. Is there anything in the phraseology of the Sixteenth Amendment or in the nature of corporate
dividends which should lead to a departure from these rules of construction and compel this court to hold, that
Congress is powerless to prevent a result so extraordinary as that here contended for by the stockholder?
First. The term 'income,' when applied to the investment of the stockholder in a corporation, had, before the
adoption of the Sixteenth Amendment, been commonly understood to mean the returns from time to time
received by the stockholder from gains or earnings of the corporation. A dividend received by a stockholder
from a corporation may be either in distribution of capital assets or in distribution of profits. Whether it is the
one or the other is in no way affected by the medium in which it is paid, nor by the method or means through
which the particular thing distributed as a dividend was procured. If the [252 U.S. 189, 227]   dividend is
declared payable in cash, the money with which to pay it is ordinarily taken from surplus cash in the treasury.
But (if there are profits legally available for distribution and the law under which the company was incorporated
so permits) the company may raise the money by discounting negotiable paper; or by selling bonds, scrip or
stock of another corporation then in the treasury; or by selling its own bonds, scrip or stock then in the
treasury; or by selling its own bonds, scrip or stock issued expressly for that purpose. How the money shall be
raised is wholly a matter of financial management. The manner in which it is raised in no way affects the
question whether the dividend received by the stockholder is income or capital; nor can it conceivably affect
the question whether it is taxable as income.
Likewise whether a dividend declared payable from profits shall be paid in cash or in some other medium is
also wholly a matter of financial management. If some other medium is decided upon, it is also wholly a
question of financial management whether the distribution shall be, for instance, in bonds, scrip or stock of
another corporation or in issues of its own. And if the dividend is paid in its own issues, why should there be a
difference in result dependent upon whether the distribution was made from such securities then in the
treasury or from others to be created and issued by the company expressly for that purpose? So far as the
distribution may be made from its own issues of bonds, or preferred stock created expressly for the purpose, it
clearly would make no difference in the decision of the question whether the dividend was a distribution of
profits, that the securities had to be created expressly for the purpose of distribution. If a dividend paid in
securities of that nature represents a distribution of profits Congress may, of course, tax it as income of the
stockholder. Is the result different where the security distributed is common stock? [252 U.S. 189,
228]   Suppose that a corporation having power to buy and sell its own stock, purchases, in the interval
between its regular dividend dates, with moneys derived from current profits, some of its own common stock
as a temporary investment, intending at the time of purchase to sell it before the next dividend date and to use
the proceeds in paying dividends, but later, deeming it inadvisable either to sell this stock or to raise by
borrowing the money necessary to pay the regular dividend in cash, declares a dividend payable in this stock;
can any one doubt that in such a case the dividend in common stock would be income of the stockholder and
constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547, 65 Atl. 1056, 8 L. R. A. (N. S.) 1011, 118
Am. St. Rep. 156, 9 Ann. Cas. 287; Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of
the stockholder subject to taxation if the purpose of the company in buying the stock so distributed had been
from the beginning to take it off the market and distribute it among the stockholders as a dividend, and the
company actually did so? And proceeding a short step further: Suppose that a corporation decided to
capitalize some of its accumulated profits by creating additional common stock and selling the same to raise
working capital, but after the stock has been issued and certificates therefor are delivered to the bankers for
sale, general financial conditions make it undesirable to market the stock and the company concludes that it is
wiser to husband, for working capital, the cash which it had intended to use in paying stockholders a dividend,
and, instead, to pay the dividend in the common stock which it had planned to sell; would not the stock so
distributed be a distribution of profits-and hence, when received, be income of the stockholder and taxable as
such? If this be conceded, why should it not be equally income of the stockholder, and taxable as such, if the
common stock created by capitalizing profits, had been originally created for the express purpose of being
distributed [252 U.S. 189, 229]   as a dividend to the stockholder who afterwards received it?
Second. It has been said that a dividend payable in bonds or preferred stock created for the purpose of
distributing profits may be income and taxable as such, but that the case is different where the distribution is in
common stock created for that purpose. Various reasons are assigned for making this distinction. One is that
the proportion of the stockholder's ownership to the aggregate number of the shares of the company is not
changed by the distribution. But that is equally true where the dividend is paid in its bonds or in its preferred
stock. Furthermore, neither maintenance nor change in the proportionate ownership of a stockholder in a
corporation has any bearing upon the question here involved. Another reason assigned is that the value of the
old stock held is reduced approximately by the value of the new stock received, so that the stockholder after
receipt of the stock dividend has no more than he had before it was paid. That is equally true whether the
dividend be paid in cash or in other property, for instance, bonds, scrip or preferred stock of the company. The
payment from profits of a large cash dividend, and even a small one, customarily lowers the then market value
of stock because the undivided property represented by each share has been correspondingly reduced. The
argument which appears to be most strongly urged for the stockholders is, that when a stock dividend is
made, no portion of the assets of the company is thereby segregated for the stockholder. But does the issue
of new bonds or of preferred stock created for use as a dividend result in any segregation of assets for the
stockholder? In each case he receives a piece of paper which entitles him to certain rights in the undivided
property. Clearly segregation of assets in a physical sense is not an essential of income. The year's gains of a
partner is taxable as income, although there, likewise, no [252 U.S. 189, 230]   segregation of his share in the
gains from that of his partners is had.
The objection that there has been no segregation is presented also in another form. It is argued that until there
is a segregation, the stockholder cannot know whether he has really received gains; since the gains may be
invested in plant or merchandise or other property and perhaps be later lost. But is not this equally true of the
share of a partner in the year's profits of the firm or, indeed, of the profits of the individual who is engaged in
business alone? And is it not true, also, when dividends are paid in cash? The gains of a business, whether
conducted by an individual, by a firm or by a corporation, are ordinarily reinvested in large part. Many a cash
dividend honestly declared as a distribution of profits, proves later to have been paid out of capital, because
errors in forecast prevent correct ascertainment of values. Until a business adventure has been completely
liquidated, it can never be determined with certainty whether there have been profits unless the returns at
least exceeded the capital originally invested. Business men, dealing with the problem practically, fix
necessarily periods and rules for determining whether there have been net profits-that is, income or gains.
They protect themselves from being seriously misled by adopting a system of depreciation charges and
reserves. Then, they act upon their own determination, whether profits have been made. Congress in
legislating has wisely adopted their practices as its own rules of action.
Third. The Government urges that it would have been within the power of Congress to have taxed as income
of the stockholder his pro rata share of undistributed profits earned, even if no stock dividend representing it
had been paid. Strong reasons may be assigned for such a view. See The Collector v. Hubbard, 12 Wall. 1.
The undivided share of a partner in the year's undistributed profits of his firm [252 U.S. 189, 231]   is taxable
as income of the partner, although the share in the gain is not evidenced by any action taken by the firm. Why
may not the stockholder's interest in the gains of the company? The law finds no difficulty in disregarding the
corporate fiction whenever that is deemed necessary to attain a just result. Linn Timber Co. v. United States,
236 U.S. 574 , 35 Sup. Ct. 440. See Morawetz on Corporations (2d Ed.) 227- 231; Cook on Corporations (7th
Ed.) 663, 664. The stockholder's interest in the property of the corporation differs, not fundamentally but in
form only, from the interest of a partner in the property of the firm. There is much authority for the proposition
that, under our law, a partnership or joint stock company is just as distinct and palpable an entity in the idea of
the law, as distinguished from the individuals composing it, as is a corporations. 5 No reason appears, why
Congress, in legislating under a grant of power so comprehensive as that authorizing the levy of an income
tax, should be limited by the particular view of the relation of the stockholder to the corporation and its
property which may, in the absence of legislation, have been taken by this court. But we have no occasion to
decide the question whether Congress might have taxed to the stockholder his undivided share of the
corporation's earnings. For Congress has in this act limited the income tax to that share of the stockholder in
the earnings which is, in effect, distributed by means of the stock dividend paid. In other words to render the
stockholder taxable there must be both earnings made and a dividend paid. Neither earnings without dividend-
nor a dividend without earnings-subjects the [252 U.S. 189, 232]   stockholder to taxation under the Revenue
Act of 1916.
Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in stock, is so
complete that serious question of the taxability of stock dividends would probably never have been made, if
Congress had undertaken to tax only those dividends which represented profits earned during the year in
which the dividend was paid or in the year preceding. But this court, construing liberally, not only the
constitutional grant of power, but also the revenue act of 1913, held that Congress might tax, and had taxed,
to the stockholder dividends received during the year, although earned by the company long before; and even
prior to the adoption of the Sixteenth Amendment. Lynch v. Hornby, 247 U.S. 339 , 38 Sup. Ct. 543.6 That
rule, if indiscriminatingly applied to all stock dividends representing profits earned, might, in view of corporate
practice, have worked considerable hardship, and have raised serious questions. Many corporations, without
legally capitalizing any part of their profits, had assigned definitely some part or all of the annual balances
remaining after paying the usual cash dividends, to the uses to which permanent capital is ordinarily applied.
Some of the corporations doing this, transferred such balances on their books to 'surplus' account-
distinguishing between such permanent 'surplus' and the 'undivided profits' account. Other corporations,
without this formality, had assumed that the annual accumulating balances carried as undistributed profits
were to be treated as capital permanently invested in the business. And still others, without definite
assumption of any kind, had [252 U.S. 189, 233]   so used undivided profits for capital purposes. To have
made the revenue law apply retroactively so as to reach such accumulated profits, if and whenever it should
be deemed desirable to capitalize them legally by the issue of additional stock distributed as a dividend to
stockholders, would have worked great injustice. Congress endeavored in the Revenue Act of 1916 to guard
against any serious hardship which might otherwise have arisen from making taxable stock dividends
representing accumulated profits. It did not limit the taxability to stock dividends representing profits earned
within the tax year or in the year preceding; but it did limit taxability to such dividends representing profits
earned since March 1, 1913. Thereby stockholders were given notice that their share also in undistributed
profits accumulating thereafter was at some time to be taxed as income. And Congress sought by section 3
(Comp. St. 1918, Comp. St. Ann. Supp. 1919, 6336c) to discourage the postponement of distribution for the
illegitimate purpose of evading liability to surtaxes.
Fifth. The decision of this court, that earnings made before the adoption of the Sixteenth Amendment, but paid
out in cash dividend after its adoption, were taxable as income of the stockholder, involved a very liberal
construction of the amendment. To hold now that earnings both made and paid out after the adoption of the
Sixteenth Amendment cannot be taxed as income of the stockholder, if paid in the form of a stock dividend,
involves an exceedingly narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland,
12 Wheat. 419, 446 (6 L. Ed. 678):
'To construe the power so as to impair its efficacy, would tend to defeat an object, in the attainment of which
the American public took, and justly took, that strong interest which arose from a full conviction of its
necessity.'
No decision heretofore rendered by this court requires us to hold that Congress, in providing for the taxation
of [252 U.S. 189, 234]   stock dividends, exceeded the power conferred upon it by the Sixteenth Amendment.
The two cases mainly relied upon to show that this was beyond the power of Congress are Towne v. Eisner,
245 U.S. 418 , 38 Sup. Ct. 158 L. R. A. 1918D, 254, which involved a question not of constitutional power but
of statutory construction, and Gibbons v. Mahon, 136 U.S. 549 , 10 Sup. Ct. 1057, which involved a question
arising between life tenant and remainderman. So far as concerns Towne v. Eisner we have only to bear in
mind what was there said ( 245 U.S. 425 , 38 Sup. Ct. 159, L. R. A. 1918D, 254): 'But it is not necessarily true
that income means the same thing in the Constitution and the [an] act.' 7 Gibbons v. Mahon is even less an
authority for a narrow construction of the power to tax incomes conferred by the Sixteenth Amendment. In that
case the court was required to determine how, in the administration of an estate in the District of Columbia, a
stock dividend, representing profits, received after the decedent's death, should be disposed of as between
life tenant and remainderman. The question was in essence: What shall the intention of the testator be
presumed to have been? On this question there was great diversity of opinion and practice in the courts of
English-speaking countries. Three well-defined rules were then competing for acceptance; two of these
involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on Corporations ( 7th
Ed.) 552-558.
1. The so-called English rule, declared in 1799, by Brander v. Brander, 4 Ves. Jr. 800, that a dividend
representing [252 U.S. 189, 235]   profits, whether in cash, stock or other property, belongs to the life tenant if
it was a regular or ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend.
2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, 96 Am. Dec. 705, that
a dividend representing profits, whether regular, ordinary or extrordinary, if in cash belongs to the life tenant,
and if in stock belongs to the remainderman.
3. The so-called Pennsylvania rule declared in 1857 by Earp's Appeal, 28 Pa. 368, that where a stock
dividend is paid, the court shall inquire into the circumstances under which the fund had been earned and
accumulated out of which the dividend, whether a regular, an ordinary or an extraordinary one, was paid. If it
finds that the stock dividend was paid out of profits earned since the decedent's death, the stock dividend
belongs to the life tenant; if the court finds that the stock dividend was paid from capital or from profits earned
before the decedent's death, the stock dividend belongs to the remainderman.
This court adopted in Gibbons v. Mahon as the rule of administration for the District of Columbia the so-called
Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice Gray. Since then the same question
has come up for decision in many of the states. The so-called Massachusetts rule, although approved by this
court, has found favor in only a few states. The so-called Pennsylvania rule, on the other hand, has been
adopted since by so many of the states (including New York and California), that it has come to be known as
the 'American rule.' Whether, in view of these facts and the practical results of the operation of the two rules
as shown by the experience of the 30 years which have elapsed since the decision in Gibbons v. Mahon, it
might be desirable for this court to reconsider the question there decided, as [252 U.S. 189, 236]   some other
courts have done (see 29 Harvard Law Review, 551), we have no occasion to consider in this case. For, as
this court there pointed out ( 136 U.S. 560 , 1059 [34 L. Ed. 525]), the question involved was one 'between the
owners of successive interests in particular shares,' and not, as in Bailey v. Railroad Co., 22 Wall. 604, a
question 'between the corporation and the government, and [which] depended upon the terms of a statute
carefully framed to prevent corporations from evading payment of the tax upon their earnings.'
incomes from whatever source derived.' They intended to include thereby everything which by reasonable
understanding can fairly be regarded as income. That stock dividends representing profits are so regarded,
not only by the plain people, but by investors and financiers, and by most of the courts of the country, is
shown, beyond peradventure, by their acts and by their utterances. It seems to me clear, therefore, that
Congress possesses the power which it exercised to make dividends representing profits, taxable as income,
whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done,
what dividends representing [252 U.S. 189, 238]   profits shall be deemed income. It surely is not clear that
the enactment exceeds the power granted by the Sixteenth Amendment. And, as this court has so often said,
the high prerogative of declaring an act of Congress invalid, should never be exercised except in a clear
case. 9  
'It is but a decent respect due to the wisdom, the integrity and the patriotism of the legislative body, by which
any law is passed, to presume in favor of its validity, until its violation of the Constitution is proved beyond all
reasonable doubt.' Ogden v. Saunders, 12 Wheat. 213, 269.
Mr. Justice CLARKE concurs in this opinion.

We have, however, not merely argument; we have examples which should convince us that 'there is no
inherent, necessary and immutable reason why stock dividends should always be treated as capital.' Tax
Commissioner v. Putnam, 227 Mass. 522, 533, 116 N. E. 904, L. R. A. 1917F. 806. The Supreme Judical
Court of Massachusetts has steadfastly adhered, despite ever-renewed protest, to the rule that every stock
dividend is, as between life tenant and remainderman, capital and not income. But in construing the
Massachusetts Income Tax Amendment, which is substantially identical with the federal amendment, that
court held that the Legislature was thereby empowered to levy an income tax upon stock dividends G.R. No. 78953             July 31, 1991
representing profits. The courts of England have, with some relaxation, adhered to their rule that every
extraordinary dividend is, as between life tenant and remainderman, to be deemed capital. But in 1913 the
Judicial Committee of the Privy Council held that a stock dividend representing accumulated profits was COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. MELCHOR J. JAVIER, JR. and THE COURT
taxable like an ordinary cash dividend, Swan Brewery Company, Limited v. The King, L. R. 1914 A. C. 231. In OF TAX APPEALS, respondents.
dismissing the appeal these words of the Chief Justice of the Supreme Court of Western Australia were
quoted (page 236) which show that the facts involved were identical with those in the case at bar: Elison G. Natividad for accused-appellant.

'Had the company distributed the 101,450 among the shareholders and had the shareholders repaid such SARMIENTO, J.:
sums to the company as the price of the 81,160 new SHARES, THE DUTY ON THE 101,450 [252 U.S. 189,
237]   WOULD CLEARLY HAVE BEEN PAYable. is not this virtually the effect of what was actually done? I
Central in this controversy is the issue as to whether or not a taxpayer who merely states as a footnote in his
think it is.'
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
Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth Amendment, return.
the owners of the most successful businesses in America will, as the facts in this case illustrate, be able to
escape taxation on a large part of what is actually their income. So far as their profits are represented by stock
This question is the subject of the petition for review before the Court of the portion of the Decision  dated July
1

received as dividends they will pay these taxes not upon their income but only upon the income of their
27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393, entitled, "Melchor J. Javier, Jr. vs.
income. That such a result was intended by the people of the United States when adopting the Sixteenth
Ruben B. Ancheta, in his capacity as Commissioner of Internal Revenue," which orders the deletion of the
Amendment is inconceivable. Our sole duty is to ascertain their intent as therein expressed. 8 In terse,
50% surcharge from Javier's deficiency income tax assessment on his income for 1977.
comprehensive language befitting the Constitution, they empowered Congress 'to lay and collect taxes on
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 imposition.
3 4
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, 1981.
6
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 which held
9
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 non-taxability of the amount he erroneously
10
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 this
14
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 imposition of the fraud penalty in this case is not justified by the
1âwphi1

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.

SO ORDERED.

G.R. No. L-65773-74 April 30, 1987

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. BRITISH OVERSEAS AIRWAYS

CORPORATION and COURT OF TAX APPEALS, respondents.

Quasha, Asperilla, Ancheta, Peña, Valmonte & Marcos for respondent British Airways.

MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the joint Decision of the
Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, dated 26 January 1983, which set aside
petitioner's assessment of deficiency income taxes against respondent British Overseas Airways Corporation
(BOAC) for the fiscal years 1959 to 1967, 1968-69 to 1970-71, respectively, as well as its Resolution of 18
November, 1983 denying reconsideration.
BOAC is a 100% British Government-owned corporation organized and existing under the laws of the United
Kingdom It is engaged in the international airline business and is a member-signatory of the Interline Air
Transport Association (IATA). As such it operates air transportation service and sells transportation tickets
over the routes of the other airline members. During the periods covered by the disputed assessments, it is
admitted that BOAC had no landing rights for traffic purposes in the Philippines, and was not granted a
Certificate of public convenience and necessity to operate in the Philippines by the Civil Aeronautics Board
(CAB), except for a nine-month period, partly in 1961 and partly in 1962, when it was granted a temporary
landing permit by the CAB. Consequently, it did not carry passengers and/or cargo to or from the Philippines,
although during the period covered by the assessments, it maintained a general sales agent in the Philippines
— Wamer Barnes and Company, Ltd., and later Qantas Airways — which was responsible for selling BOAC
tickets covering passengers and cargoes. 1
G.R. No. 65773  (CTA Case No. 2373, the First Case)
On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed BOAC the
aggregate amount of P2,498,358.56 for deficiency income taxes covering the years 1959 to 1963. This was
protested by BOAC. Subsequent investigation resulted in the issuance of a new assessment, dated 16
January 1970 for the years 1959 to 1967 in the amount of P858,307.79. BOAC paid this new assessment
under protest.
On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which claim was denied by
the CIR on 16 February 1972. But before said denial, BOAC had already filed a petition for review with the
Tax Court on 27 January 1972, assailing the assessment and praying for the refund of the amount paid.
G.R. No. 65774  (CTA Case No. 2561, the Second Case)
On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for the fiscal
years 1968-1969 to 1970-1971 in the aggregate amount of P549,327.43, and the additional amounts of
P1,000.00 and P1,800.00 as compromise penalties for violation of Section 46 (requiring the filing of
corporation returns) penalized under Section 74 of the National Internal Revenue Code (NIRC).
On 25 November 1971, BOAC requested that the assessment be countermanded and set aside. In a letter,
dated 16 February 1972, however, the CIR not only denied the BOAC request for refund in the First Case but
also re-issued in the Second Case the deficiency income tax assessment for P534,132.08 for the years 1969
to 1970-71 plus P1,000.00 as compromise penalty under Section 74 of the Tax Code. BOAC's request for
reconsideration was denied by the CIR on 24 August 1973. This prompted BOAC to file the Second Case
before the Tax Court praying that it be absolved of liability for deficiency income tax for the years 1969 to
1971.
This case was subsequently tried jointly with the First Case.
On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the CIR. The Tax Court
held that the proceeds of sales of BOAC passage tickets in the Philippines by Warner Barnes and Company,
Ltd., and later by Qantas Airways, during the period in question, do not constitute BOAC income from
Philippine sources "since no service of carriage of passengers or freight was performed by BOAC within the
Philippines" and, therefore, said income is not subject to Philippine income tax. The CTA position was that
income from transportation is income from services so that the place where services are rendered determines
the source. Thus, in the dispositive portion of its Decision, the Tax Court ordered petitioner to credit BOAC
with the sum of P858,307.79, and to cancel the deficiency income tax assessments against BOAC in the
amount of P534,132.08 for the fiscal years 1968-69 to 1970-71.
Hence, this Petition for Review on certiorari of the Decision of the Tax Court.
The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:
1. Whether or not the revenue derived by private respondent British Overseas Airways
Corporation (BOAC) from sales of tickets in the Philippines for air transportation, while
having no landing rights here, constitute income of BOAC from Philippine sources, and,
accordingly, taxable.
2. Whether or not during the fiscal years in question BOAC s a resident foreign corporation
doing business in the Philippines or has an office or place of business in the Philippines.
3. In the alternative that private respondent may not be considered a resident foreign
corporation but a non-resident foreign corporation, then it is liable to Philippine income tax
at the rate of thirty-five per cent (35%) of its gross income received from all sources within
the Philippines.
Under Section 20 of the 1977 Tax Code:
(h) the term resident foreign corporation engaged in trade or business within the Philippines
or having an office or place of business therein.
(i) The term "non-resident foreign corporation" applies to a foreign corporation not engaged
in trade or business within the Philippines and not having any office or place of business
therein
It is our considered opinion that BOAC is a resident foreign corporation. 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
2
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.  3
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
4
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 lifeblood 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.  5
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 fife 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. (Emphasis supplied)
Next, we address ourselves to the issue of whether or not the revenue from sales of tickets by BOAC in the
Philippines constitutes income from Philippine sources and, accordingly, taxable under our income tax laws.
The Tax Code defines "gross income" thus:
"Gross income" includes gains, profits, and income derived from salaries, wages or
compensation for personal service of whatever kind and in whatever form paid, or from
profession, vocations, trades, business, commerce, sales, or dealings in property, whether
real or personal, growing out of the ownership or use of or interest in such property; also
from interests, rents, dividends, securities, or the transactions of any business carried on for
gain or profile, or gains, profits, and income derived from any source whatever (Sec. 29[3];
Emphasis supplied)
The definition is broad and comprehensive to include proceeds from sales of transport documents. "The
words 'income from any source whatever' disclose a legislative policy to include all income not expressly
exempted within the class of taxable income under our laws." Income means "cash received or its equivalent";
it is the amount of money coming to a person within a specific time ...; it means something distinct from
principal or capital. For, while capital is a fund, income is a flow. As used in our income tax law, "income"
refers to the flow of wealth. 
6
The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to 1970-71 amounted
to P10,428,368 .00.  7
Did such "flow of wealth" come from "sources within the Philippines",
The source of an income is the property, activity or service that produced the income.   For the source of
8
income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity
within the Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity that produces the
income. The tickets exchanged hands here and payments for fares were also made here in Philippine
currency. The site of the source of payments is the Philippines. The flow of wealth proceeded from, and
occurred within, Philippine territory, enjoying the protection accorded by the Philippine government. In
consideration of such protection, the flow of wealth should share the burden of supporting the government.
A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the
contract between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser of the ticket to
pay the fare and the corresponding obligation of the carrier to transport the passenger upon the terms and
conditions set forth thereon. The ordinary ticket issued to members of the traveling public in general embraces
within its terms all the elements to constitute it a valid contract, binding upon the parties entering into the
relationship. 
9
True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources within the
Philippines, namely: (1) interest, (21) dividends, (3) service, (4) rentals and royalties, (5) sale of real property,
and (6) sale of personal property, does not mention income from the sale of tickets for international
transportation. However, that does not render it less an income from sources within the Philippines. Section
37, by its language, does not intend the enumeration to be exclusive. It merely directs that the types of income
listed therein be treated as income from sources within the Philippines. A cursory reading of the section will
show that it does not state that it is an all-inclusive enumeration, and that no other kind of income may be so
considered. " 10
BOAC, however, would impress upon this Court that income derived from transportation is income for
services, with the result that the place where the services are rendered determines the source; and since
BOAC's service of transportation is performed outside the Philippines, the income derived is from sources
without the Philippines and, therefore, not taxable under our income tax laws. The Tax Court upholds that
stand in the joint Decision under review.
The absence of flight operations to and from the Philippines is not determinative of the source of income or
the site of income taxation. Admittedly, BOAC was an off-line international airline at the time pertinent to this
case. The test of taxability is the "source"; and the source of an income is that activity ... which produced the
income. Unquestionably, the passage documentations in these cases were sold in the Philippines and the
revenue therefrom was derived from a activity regularly pursued within the Philippines. business a And even if
the BOAC tickets sold covered the "transport of passengers and cargo to and from foreign cities",  it cannot
alter the fact that income from the sale of tickets was derived from the Philippines. The word "source" conveys
one essential idea, that of origin, and the origin of the income herein is the Philippines. 
It should be pointed out, however, that the assessments upheld herein apply only to the fiscal years covered
by the questioned deficiency income tax assessments in these cases, or, from 1959 to 1967, 1968-69 to
1970-71. For, pursuant to Presidential Decree No. 69, promulgated on 24 November, 1972, international
carriers are now taxed as follows:
... Provided, however, That international carriers shall pay a tax of 2-½ per cent on their
cross Philippine billings. (Sec. 24[b] [21, Tax Code).
Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory definition of the term
"gross Philippine billings," thus:

... "Gross Philippine billings" includes gross revenue realized from uplifts anywhere in the
world by any international carrier doing business in the Philippines of passage documents
sold therein, whether for passenger, excess baggage or mail provided the cargo or mail
originates from the Philippines. ...

The foregoing provision ensures that international airlines are taxed on their income from Philippine sources.
The 2-½ % tax on gross Philippine billings is an income tax. If it had been intended as an excise or
percentage tax it would have been place under Title V of the Tax Code covering Taxes on Business.

Lastly, we find as untenable the BOAC argument that the dismissal for lack of merit by this Court of the appeal
in JAL vs. Commissioner of Internal Revenue (G.R. No. L-30041) on February 3, 1969, is res judicata to the
present case. The ruling by the Tax Court in that case was to the effect that the mere sale of tickets,
unaccompanied by the physical act of carriage of transportation, does not render the taxpayer therein subject
to the common carrier's tax. As elucidated by the Tax Court, however, the common carrier's tax is an excise
tax, being a tax on the activity of transporting, conveying or removing passengers and cargo from one place to
another. It purports to tax the business of transportation. 14 Being an excise tax, the same can be levied by
the State only when the acts, privileges or businesses are done or performed within the jurisdiction of the
Philippines. The subject matter of the case under consideration is income tax, a direct tax on the income of
persons and other entities "of whatever kind and in whatever form derived from any source." Since the two
cases treat of a different subject matter, the decision in one cannot be res judicata to the other.

WHEREFORE, the appealed joint Decision of the Court of Tax Appeals is hereby SET ASIDE. Private
respondent, the British Overseas Airways Corporation (BOAC), is hereby ordered to pay the amount of
P534,132.08 as deficiency income tax for the fiscal years 1968-69 to 1970-71 plus 5% surcharge, and 1%
monthly interest from April 16, 1972 for a period not to exceed three (3) years in accordance with the Tax
Code. The BOAC claim for refund in the amount of P858,307.79 is hereby denied. Without costs.

SO ORDERED.

G.R. No. L-66416 March 21, 1990

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. TOURS SPECIALISTS, INC., and THE COURT
OF TAX APPEALS, respondents.

Gadioma Law Offices for private respondent.

GUTIERREZ, JR., J.:
This is a petition to review on certiorari the decision of the Court of Tax Appeals which ruled that the money per investigation P 3,995.63
entrusted to private respondent Tours Specialists, Inc., earmarked and paid for hotel room charges of tourists,
travelers and/or foreign travel agencies does not form part of its gross receipts subject to the 3% independent 15% surcharge for late payment 998.91
contractor's tax under the National Internal Revenue Code of 1977.
—————
We adopt the findings of facts of the Court of Tax Appeals as follows:
P 4,994.54
For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived income from its
activities as a travel agency by servicing the needs of foreign tourists and travelers and
Filipino "Balikbayans" during their stay in this country. Some of the services extended to the 14% interest computed by quarters
tourists consist of booking said tourists and travelers in local hotels for their lodging and
board needs; transporting these foreign tourists from the airport to their respective hotels, up to 12-28-79 3,953.18 P 8,847.72
and from the latter to the airport upon their departure from the Philippines, transporting them
from their hotels to various embarkation points for local tours, visits and excursions; 1975 deficiency percentage tax
securing permits for them to visit places of interest; and arranging their cultural
entertainment, shopping and recreational activities.
per investigation P 8,427.39
In order to ably supply these services to the foreign tourists, petitioner and its correspondent
counterpart tourist agencies abroad have agreed to offer a package fee for the tourists. 25% surcharge for late payment 2,106.85
Although the fee to be paid by said tourists is quoted by the petitioner, the payments of the
hotel room accommodations, food and other personal expenses of said tourists, as a rule, —————
are paid directly either by tourists themselves, or by their foreign travel agencies to the local
hotels (pp. 77, t.s.n., February 2, 1981; Exhs. O & O-1, p. 29, CTA rec.; pp. 2425,
P 10,534.24
t.s.n., ibid) and restaurants or shops, as the case may be.

14% interest computed by quarters

It is also the case that some tour agencies abroad request the local tour agencies, such as
the petitioner in the case, that the hotel room charges, in some specific cases, be paid
through them. (Exh. Q, Q-1, p. 29 CTA rec., p. 25, T.s.n., ibid, pp. 5-6, 17-18, t.s.n., Aug. up to 12-28-79 6,808.47 P 17,342.71
20, 1981.; See also Exh. "U", pp. 22-23, t.s.n., Oct. 9, 1981, pp. 3-4, 11., t.s.n., Aug. 10,
1982). By this arrangement, the foreign tour agency entrusts to the petitioner Tours 1976 deficiency percentage
Specialists, Inc., the fund for hotel room accommodation, which in turn is paid by petitioner
tour agency to the local hotel when billed. The procedure observed is that the billing hotel
per investigation P 54,276.42
sends the bill to the petitioner. The local hotel identifies the individual tourist, or the
particular groups of tourists by code name or group designation and also the duration of
their stay for purposes of payment. Upon receipt of the bill, the petitioner then pays the local 25% surcharge for late payment 13,569.11
hotel with the funds entrusted to it by the foreign tour correspondent agency.
—————
Despite this arrangement, respondent Commissioner of Internal Revenue assessed
petitioner for deficiency 3% contractor's tax as independent contractor by including the P 67,845.53
entrusted hotel room charges in its gross receipts from services for the years 1974 to 1976.
Consequently, on December 6, 1979, petitioner received from respondent the 3% deficiency
independent contractor's tax assessment in the amount of P122,946.93 for the years 1974 14% interest computed by quarters
to 1976, inclusive, computed as follows:
up to 12-28-79 28,910.97 P 96,756.50
1974 deficiency percentage tax
————— —————
 Total amount due P 122,946.93
=========
In addition to the deficiency contractor's tax of P122,946.93, petitioner was assessed to pay
a compromise penalty of P500.00.
Subsequently on December 11, 1979, petitioner formally protested the assessment made
by respondent on the ground that the money received and entrusted to it by the tourists,
earmarked to pay hotel room charges, were not considered and have never been
considered by it as part of its taxable gross receipts for purposes of computing and paying
its constractor's tax.
During one of the hearings in this case, a witness, Serafina Sazon, Certified Public
Accountant and in charge of the Accounting Department of petitioner, had testified, her
credibility not having been destroyed on cross examination, categorically stated that the
amounts entrusted to it by the foreign tourist agencies intended for payment of hotel room
charges, were paid entirely to the hotel concerned, without any portion thereof being
diverted to its own funds. (t.s.n., Feb.  2, 1981, pp. 7, 25; t.s.n., Aug.  20, 1981, pp. 5-9, 17-
18). The testimony of Serafina Sazon was corroborated by Gerardo Isada, General
Manager of petitioner, declaring to the effect that payments of hotel accommodation are
made through petitioner without any increase in the room charged (t.s.n., Oct.  9, 1981, pp.
21-25) and that the reason why tourists pay their room charge, or through their foreign
tourists agencies, is the fact that the room charge is exempt from hotel room tax under P.D.
31. (t.s.n., Ibid., pp. 25-29.) Witness Isada stated, on cross-examination, that if their
payment is made, thru petitioner's tour agency, the hotel cost or charges "is only an act of
accomodation on our (its) part" or that the "agent abroad instead of sending several telexes
and saving on bank charges they take the option to send money to us to be held in trust to
be endorsed to the hotel." (pp. 3-4, t.s.n. Aug.  10, 1982.)
Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's written protest,
caused the issuance of a warrant of distraint and levy. (p. 51, BIR Rec.) And later,
respondent had petitioner's bank deposits garnished. (pp. 49-50, BIR Rec.)
Taking this action of respondent as the adverse and final decision on the disputed
assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)
The petitioner raises the lone issue in this petition as follows:
WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL AGENCY
INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN TOUR AGENCIES,
INTENDED OR EARMARKED FOR HOTEL ACCOMMODATIONS FORM PART OF
GROSS RECEIPTS SUBJECT TO 3% CONTRACTOR'S TAX. (Rollo, p. 23)
The petitioner premises the issue raised on the following assumptions:
Firstly, the ruling overlooks the fact that the amounts received, intended for hotel room
accommodations, were received as part of the package fee and, therefore, form part of
"gross receipts" as defined by law.
Secondly, there is no showing and is not established by the evidence. that the amounts
received and "earmarked" are actually what had been paid out as hotel room charges. The
mere possibility that the amounts actually paid could be less than the amounts received is
sufficient to destroy the validity of the ruling. (Rollo, pp. 26-27)
In effect, the petitioner's lone issue is based on alleged error in the findings of facts of the respondent court.
The well-settled doctrine is that the findings of facts of the Court of Tax Appeals are binding on this Court and
absent strong reasons for this Court to delve into facts, only questions of law are open for determination.
(Nilsen v. Commissioner of Customs, 89 SCRA 43 [1979]; Balbas v. Domingo, 21 SCRA 444 [1967];
Raymundo v. De Joya, 101 SCRA 495 [1980]). In the recent case of Sy Po v. Court of Appeals, (164 SCRA
524 [1988]), we ruled that the factual findings of the Court of Tax Appeals are binding upon this court and can
only be disturbed on appeal if not supported by substantial evidence.
In the instant case, we find no reason to disregard and deviate from the findings of facts of the Court of Tax
Appeals.
As quoted earlier, the Court of Tax Appeals sufficiently explained the services of a local travel agency, like the
herein private respondent, rendered to foreign customers. The respondent differentiated between the package
fee — offered by both the local travel agency and its correspondent counterpart tourist agencies abroad and
the requests made by some tour agencies abroad to local tour agencies wherein the hotel room charges in
some specific cases, would be paid to the local hotels through them. In the latter case, the correspondent
court found as a fact ". . . that the foreign tour agency entrusts to the petitioner Tours Specialists, Inc. the fund
for hotel room accommodation, which in turn is paid by petitioner tour agency to the local hotel when billed."
(Rollo, p. 42) The following procedure is followed: The billing hotel sends the bill to the respondent; the local
hotel then identifies the individual tourist, or the particular group of tourist by code name or group designation
plus the duration of their stay for purposes of payment; upon receipt of the bill the private respondent pays the
local hotel with the funds entrusted to it by the foreign tour correspondent agency.
Moreover, evidence presented by the private respondent shows that the amounts entrusted to it by the foreign
tourist agencies to pay the room charges of foreign tourists in local hotels were not diverted to its funds; this
arrangement was only an act of accommodation on the part of the private respondent. This evidence was not
refuted.
In essence, the petitioner's assertion that the hotel room charges entrusted to the private respondent were
part of the package fee paid by foreign tourists to the respondent is not correct. The evidence is clear to the
effect that the amounts entrusted to the private respondent were exclusively for payment of hotel room
charges of foreign tourists entrusted to it by foreign travel agencies.
As regards the petitioner's second assumption, the respondent court stated:
 . . . [C]ontrary to the contention of respondent, the records show, firstly, in the Examiners' . . . [W]hether or not the hotel room charges held in trust for foreign tourists and travelers
Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December 1976 alone, the following and/or correspondent foreign travel agencies and paid to local host hotels form part of the
sums made up the hotel room accommodations: taxable gross receipts for purposes of the 3% contractor's tax. (Rollo, p. 45)

July 1976 P 102,702.97 The petitioner opines that the gross receipts which are subject to the 3% contractor's tax pursuant to Section
191 (Section 205 of the National Internal Revenue Code of 1977) of the Tax Code include the entire gross
Aug. 1976 121,167.19 receipts of a taxpayer undiminished by any amount. According to the petitioner, this interpretation is in
consonance with B.I.R. Ruling No. 68-027, dated 23 October, 1968 (implementing Section 191 of the Tax
Code) which states that the 3% contractor's tax prescribed by Section 191 of the Tax Code is imposed of the
Sept. 1976 53,209.61 gross receipts of the contractor, "no deduction whatever being allowed by said law." The petitioner contends
that the only exception to this rule is when there is a law or regulation which would exempt such gross receipts
————— from being subjected to the 3% contractor's tax citing the case of Commissioner of Internal Revenue v.  Manila
Jockey Club, Inc. (108 Phil. 821 [1960]). Thus, the petitioner argues that since there is no law or regulation
P 282,079.77 that money entrusted, earmarked and paid for hotel room charges should not form part of the gross receipts,
then the said hotel room charges are included in the private respondent's gross receipts for purposes of the
3% contractor's tax.
=========
In the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (supra), the Commissioner
Oct. 1976 P 71,134.80 appealed two decisions of the Court of Tax Appeals disapproving his levy of amusement taxes upon the
Manila Jockey Club, a duly constituted corporation authorized to hold horse races in Manila. The facts of the
Nov. 1976 409,019.17 case show that the monies sought to be taxed never really belonged to the club. The decision shows that
during the period November 1946 to 1950, the Manila Jockey Club paid amusement tax on its commission but
without including the 5-1/2% which pursuant to Executive Order 320 and Republic Act 309 went to the Board
Dec. 1976 142,761.55
of Races, the owner of horses and jockeys. Section 260 of the Internal Revenue Code provides that the
amusement tax was payable by the operator on its "gross receipts". The Manila Jockey Club, however, did not
————— consider as part of its "gross receipts" subject to amusement tax the amounts which it had to deliver to the
Board on Races, the horse owners and the jockeys. This view was fully sustained by three opinions of the
622,915.51 Secretary of Justice, to wit:

—————
Grand Total P 904,995.29
=========
It is not true therefore, as stated by respondent, that there is no evidence proving the
amounts earmarked for hotel room charges. Since the BIR examiners could not have
manufactured the above figures representing "advances for hotel room accommodations,"
these payments must have certainly been taken from the records of petitioner, such as the
invoices, hotel bills, official receipts and other pertinent documents. (Rollo, pp. 48-49)
The factual findings of the respondent court are supported by substantial evidence, hence binding upon this
Court.
With these clarifications, the issue to be threshed out is as stated by the respondent court, to wit:
There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the total bets
registered by the Totalizer. This portion represents its share or commission in the total
amount of money it handles and goes to the funds thereof as its own property which it may
legally disburse for its own purposes. The 5% does not belong to the club. It is merely held
in trust for distribution as prizes to the owners of winning horses. It is destined for no other
object than the payment of prizes and the club cannot otherwise appropriate this portion
without incurring liability to the owners of winning horses. It cannot be considered as an item
of expense because the sum used for the payment of prizes is not taken from the funds of
the club but from a certain portion of the total bets especially earmarked for that purpose.
In view of all the foregoing, I am of the opinion that in the submission of the returns for the
amusement tax of 10% (now it is 20% of the "gross receipts", provided for in Section 260 of
the National Internal Revenue Code), the 5% of the total bets that is set aside for prizes to
owners of winning horses should not be included by the Manila Jockey Club, Inc.
The Collector of the Internal Revenue, however had a different opinion on the matter and demanded payment
of amusement taxes. The Court of Tax Appeals reversed the Collector.
We affirmed the decision of the Court of Tax Appeals and stated:
The Secretary's opinion was correct. The Government could not have meant to tax as gross
receipt of the Manila Jockey Club the 1/2% which it directs same Club to turn over to the
Board on Races. The latter being a Government institution, there would be double taxation,
which should be avoided unless the statute admits of no other interpretation. In the same
manner, the Government could not have intended to consider as gross receipt the portion of
the funds which it directed the Club to give, or knew the Club would give, to winning horses
and jockeys — admittedly 5%. It is true that the law says that out of the total wager funds
12-1/2% shall be set aside as the "commission" of the race track owner, but the law itself
takes official notice, and actually approves or directs payment of the portion that goes to
owners of horses as prizes and bonuses of jockeys, which portion is admittedly 5% out of
that 12-1/2% commission. As it did not at that time contemplate the application of "gross
receipts" revenue principle, the law in making a distribution of the total wager funds, took no
trouble of separating one item from the other; and for convenience, grouped three items
under one common denomination.
Needless to say, gross receipts of the proprietor of the amusement place should not include
any money which although delivered to the amusement place has been especially
earmarked by law or regulation for some person other than the proprietor. (The situation
thus differs from one in which the owner of the amusement place, by a private contract, with
its employees or partners, agrees to reserve for them a portion of the proceeds of the
establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55 Off. Gaz. [51] 10539; Sy Chuico
v. Coll., 107 Phil., 428; 59 Off. Gaz., [6] 896).
In the second case, the facts of the case are:
The Manila Jockey Club holds once a year a so called "special Novato race", wherein only
"novato" horses, (i.e. horses which are running for the first time in an official [of the club]
race), may take part. Owners of these horses must pay to the Club an inscription fee of
P1.00, and a declaration fee of P1.00 per horse. In addition, each of them must contribute to
a common fund (P10.00 per horse). The Club contributes an equal amount P10.00 per
horse) to such common fund, the total amount of which is added to the 5% participation of
horse owners already described herein-above in the first case.
Since the institution of this yearly special novato race in 1950, the Manila Jockey Club never
paid amusement tax on the moneys thus contributed by horse owners (P10.00 each)
because it entertained the belief that in accordance with the three opinions of the Secretary
of Justice herein-above described, such contributions never formed part of its gross
receipts. On the inscription fee of the P1.00 per horse, it paid the tax. It did not on the
declaration fee of P1.00 because it was imposed by the Municipal Ordinance of Manila and
was turned over to the City officers.
The Collector of Internal Revenue required the Manila Jockey Club to pay amusement tax
on such contributed fund P10.00 per horse in the special novato race, holding they were
part of its gross receipts. The Manila Jockey Club protested and resorted to the Court of Tax
Appeals, where it obtained favorable judgment on the same grounds sustained by said
Court in connection with the 5% of the total wager funds in the herein-mentioned first case;
they were not receipts of the Club.
We resolved the issue in the following manner:
We think the reasons for upholding the Tax Court's decision in the first case apply to this
one. The ten-peso contribution never belonged to the Club. It was held by it as a trust fund.
And then, after all, when it received the ten-peso contribution, it at the same time
contributed ten pesos out of its own pocket, and thereafter distributed both amounts as
prizes to horse owners. It would seem unreasonable to regard the ten-peso contribution of
the horse owners as taxable receipt of the Club, since the latter, at the same moment it
received the contribution necessarily lost ten pesos too.
As demonstrated in the above-mentioned case,  gross receipts subject to tax under the Tax Code do not
include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound to the
taxpayer's benefit; and it is not necessary that there must be a law or regulation which would exempt such
monies and receipts within the meaning of gross receipts under the Tax Code.
Parenthetically, the room charges entrusted by the foreign travel agencies to the private respondent do not
form part of its gross receipts within the definition of the Tax Code. The said receipts never belonged to the
private respondent. The private respondent never benefited from their payment to the local hotels. As stated
earlier, this arrangement was only to accommodate the foreign travel agencies.
Another objection raised by the petitioner is to the respondent court's application of Presidential Decree 31
which exempts foreign tourists from payment of hotel room tax. Section 1 thereof provides:
Sec. 1. — Foreign tourists and travelers shall be exempt from payment of any and all hotel
room tax for the entire period of their stay in the country.
The petitioner now alleges that P.D. 31 has no relevance to the case. He contends that the tax under Section
191 of the Tax Code is in the nature of an excise tax; that it is a tax on the exercise of the privilege to engage
in business as a contractor and that it is imposed on, and collectible from the person exercising the privilege.
He sums his arguments by stating that "while the burden may be shifted to the person for whom the services
are rendered by the contractor, the latter is not relieved from payment of the tax." (Rollo, p. 28)
The same arguments were submitted by the Commissioner of Internal Revenue in the case of Commissioner
of Internal Revenue v.  John Gotamco & Son.,  Inc. (148 SCRA 36 [1987]), to justify his imposition of the 3%
contractor's tax under Section 191 of the National Internal Revenue Code on the gross receipts John
Gotamco & Sons, Inc., realized from the construction of the World Health Organization (WHO) office building
in Manila. We rejected the petitioner's arguments and ruled:
We agree with the Court of Tax Appeals in rejecting this contention of the petitioner. Said
the respondent court:
 "In context, direct taxes are those that are demanded from the very WHEREFORE, the instant petition is DENIED. The decision of the Court of Tax Appeals is AFFIRMED. No
person who, it is intended or desired, should pay them; while indirect pronouncement as to costs.
taxes are those that are demanded in the first instance from one person in
the expectation and intention that he can shift the burden to someone SO ORDERED
else. (Pollock v. Farmers, L & T Co., 1957 US 429, 15 S. Ct. 673, 39 Law.
ed. 759). The contractor's tax is of course payable by the contractor but in
the last analysis it is the owner of the building that shoulders the burden
of the tax because the same is shifted by the contractor to the owner as a
matter of self-preservation. Thus, it is an indirect tax. And it is an indirect
tax on the WHO because, although it is payable by the petitioner, the
latter can shift its burden on the WHO. In the last analysis it is the WHO
that will pay the tax indirectly through the contractor and it certainly
cannot be said that 'this tax has no bearing upon the World Health
Organization.'"

Petitioner claims that under the authority of the Philippine Acetylene Company versus
Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3% contractor's tax falls
directly on Gotamco and cannot be shifted to the WHO. The Court of Tax Appeals,
however, held that the said case is not controlling in this case, since the Host Agreement
specifically exempts the WHO from "indirect taxes." We agree. The Philippine Acetylene
case involved a tax on sales of goods which under the law had to be paid by the
manufacturer or producer; the fact that the manufacturer or producer might have added the
amount of the tax to the price of the goods did not make the sales tax "a tax on the
purchaser." The Court held that the sales tax must be paid by the manufacturer or producer
even if the sale is made to tax-exempt entities like the National Power Corporation, an
agency of the Philippine Government, and to the Voice of America, an agency of the United
States Government.

The Host Agreement, in specifically exempting the WHO from "indirect taxes," contemplates
taxes which, although not imposed upon or paid by the Organization directly, form part of
the price paid or to be paid by it.

Accordingly, the significance of P.D. 31 is clearly established in determining whether or not hotel room
charges of foreign tourists in local hotels are subject to the 3% contractor's tax. As the respondent court aptly
stated:

. . . If the hotel room charges entrusted to petitioner will be subjected to 3% contractor's tax
as what respondent would want to do in this case, that would in effect do indirectly what
P.D. 31 would not like hotel room charges of foreign tourists to be subjected to hotel room
tax. Although, respondent may claim that the 3% contractor's tax is imposed upon a
different incidence i.e. the gross receipts of petitioner tourist agency which he asserts G.R. No. L-21551             September 30, 1969
includes the hotel room charges entrusted to it, the effect would be to impose a tax, and
though different, it nonetheless imposes a tax actually on room charges. One way or the FERNANDEZ HERMANOS, INC., petitioner, vs. COMMISSIONER OF INTERNAL REVENUE and COURT
other, it would not have the effect of promoting tourism in the Philippines as that would OF TAX APPEALS, respondents.
increase the costs or expenses by the addition of a hotel room tax in the overall expenses of
said tourists. (Rollo, pp. 51-52) -----------------------------
G.R. No. L-21557             September 30, 1969 The taxpayer, Fernandez Hermanos, Inc., is a domestic corporation organized for the principal purpose of
engaging in business as an "investment company" with main office at Manila. Upon verification of the
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. FERNANDEZ HERMANOS, INC., and COURT taxpayer's income tax returns for the period in question, the Commissioner of Internal Revenue assessed
OF TAX APPEALS, respondents. against the taxpayer the sums of P13,414.00, P119,613.00, P11,698.00, P6,887.00 and P14,451.00 as
alleged deficiency income taxes for the years 1950, 1951, 1952, 1953 and 1954, respectively. Said
assessments were the result of alleged discrepancies found upon the examination and verification of the
----------------------------- taxpayer's income tax returns for the said years, summarized by the Tax Court in its decision of June 10, 1963
in CTA Case No. 787, as follows:
G.R. No. L-24972             September 30, 1969
1. Losses —
COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. FERNANDEZ HERMANOS INC., and the
COURT OF TAX APPEALS, respondents. a. Losses in Mati Lumber Co. (1950)          P 8,050.00

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

G.R. No. L-24978             September 30, 1969 c. Losses in Balamban Coal Mines —

FERNANDEZ HERMANOS, INC., petitioner, vs. THE COMMISSIONER OF INTERNAL REVENUE, and 1950 8,989.76
HON. ROMAN A. UMALI, COURT OF TAX APPEALS, respondents.
1951 27,732.66

L-21551:
Rafael Dinglasan for petitioner. Office of the Solicitor General Arturo A. Alafriz, Solicitor Alejandro B. Afurong d. Losses in Hacienda Dalupiri —
and Special Attorney Virgilio G. Saldajeno for respondent.
L-21557: 1950 17,418.95
Office of the Solicitor General for petitioner. Rafael Dinglasan for respondent Fernandez Hermanos, Inc. 1951 29,125.82
L-24972: 1952 26,744.81
Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General Felicisimo R. Rosete and
1953 21,932.62
Special Attorney Virgilio G. Saldajeno for petitioner. Rafael Dinglasan for respondent Fernandez Hermanos,
Inc. 1954 42,938.56
L-24978:
Rafael Dinglasan for petitioner. Office of the Solicitor General Antonio P. Barredo, Assistant Solicitor General e. Losses in Hacienda Samal —
Antonio G. Ibarra and Special Attorney Virgilio G. Saldajeno for respondent.
1951 8,380.25
1952 7,621.73
TEEHANKEE, J.:
2. Excessive depreciation of Houses —
These four appears involve two decisions of the Court of Tax Appeals determining the taxpayer's income tax
liability for the years 1950 to 1954 and for the year 1957. Both the taxpayer and the Commissioner of Internal
Revenue, as petitioner and respondent in the cases a quo respectively, appealed from the Tax Court's 1950 P 8,180.40
decisions, insofar as their respective contentions on particular tax items were therein resolved against them. 1951 8,768.11
Since the issues raised are interrelated, the Court resolves the four appeals in this joint decision. 1952 18,002.16
1953 13,655.25
Cases L-21551 and L-21557 1954 29,314.98

3. Taxable increase in net worth —

 1950 P 30,050.00
1951 1,382.85
4. Gain realized from sale of real property in 1950          P 11,147.2611
The Tax Court sustained the Commissioner's disallowances of Item 1, sub-items (b) and (e) and Item
2 of the above summary, but overruled the Commissioner's disallowances of all the remaining items.
It therefore modified the deficiency assessments accordingly, found the total deficiency income taxes
due from the taxpayer for the years under review to amount to P123,436.00 instead of P166,063.00
as originally assessed by the Commissioner, and rendered the following judgment:
RESUME
1950 P2,748.00
1951 108,724.00
1952 3,600.00
1953 2,501.00
1954 5,863.00
Total P123,436.00
WHEREFORE, the decision appealed from is hereby modified, and petitioner is ordered to pay the
sum of P123,436.00 within 30 days from the date this decision becomes final. If the said amount, or
any part thereof, is not paid within said period, there shall be added to the unpaid amount as
surcharge of 5%, plus interest as provided in Section 51 of the National Internal Revenue Code, as
amended. With costs against petitioner. (Pp. 75, 76, Taxpayer's Brief as appellant)
Both parties have appealed from the respective adverse rulings against them in the Tax Court's decision. Two
main issues are raised by the parties: first, the correctness of the Tax Court's rulings with respect to the
disputed items of disallowances enumerated in the Tax Court's summary reproduced above, and second,
whether or not the government's right to collect the deficiency income taxes in question has already
prescribed.
On the first issue, we will discuss the disputed items of disallowances seriatim.
1. Re allowances/disallowances of losses.
(a) Allowance of losses in Mati Lumber Co. (1950). — The Commissioner of Internal Revenue questions the
Tax Court's allowance of the taxpayer's writing off as worthless securities in its 1950 return the sum of
P8,050.00 representing the cost of shares of stock of Mati Lumber Co. acquired by the taxpayer on January 1,
1948, on the ground that the worthlessness of said stock in the year 1950 had not been clearly established.
The Commissioner contends that although the said Company was no longer in operation in 1950, it still had its
sawmill and equipment which must be of considerable value. The Court, however, found that "the company
ceased operations in 1949 when its Manager and owner, a certain Mr. Rocamora, left for Spain ,where he
subsequently died. When the company eased to operate, it had no assets, in other words, completely
insolvent. This information as to the insolvency of the Company — reached (the taxpayer) in 1950," when it
properly claimed the loss as a deduction in its 1950 tax return, pursuant to Section 30(d) (4) (b) or Section 30
(e) (3) of the National Internal Revenue Code. 2
We find no reason to disturb this finding of the Tax Court. There was adequate basis for the writing off of the
stock as worthless securities. Assuming that the Company would later somehow realize some proceeds from
its sawmill and equipment, which were still existing as claimed by the Commissioner, and that such proceeds
would later be distributed to its stockholders such as the taxpayer, the amount so received by the taxpayer
would then properly be reportable as income of the taxpayer in the year it is received.
(b) Disallowance of losses in or bad debts of Palawan Manganese Mines, Inc. (1951). — The taxpayer
appeals from the Tax Court's disallowance of its writing off in 1951 as a loss or bad debt the sum of
P353,134.25, which it had advanced or loaned to Palawan Manganese Mines, Inc. The Tax Court's findings
on this item follow:
Sometime in 1945, Palawan Manganese Mines, Inc., the controlling stockholders of which are also
the controlling stockholders of petitioner corporation, requested financial help from petitioner to
enable it to resume it mining operations in Coron, Palawan. The request for financial assistance was
readily and unanimously approved by the Board of Directors of petitioner, and thereafter a
memorandum agreement was executed on August 12, 1945, embodying the terms and conditions
under which the financial assistance was to be extended, the pertinent provisions of which are as
follows:
"WHEREAS, the FIRST PARTY, by virtue of its resolution adopted on August 10, 1945, has
agreed to extend to the SECOND PARTY the requested financial help by way of
accommodation advances and for this purpose has authorized its President, Mr. Ramon J.
Fernandez to cause the release of funds to the SECOND PARTY.
"WHEREAS, to compensate the FIRST PARTY for the advances that it has agreed to
extend to the SECOND PARTY, the latter has agreed to pay to the former fifteen per
centum (15%) of its net profits.
"NOW THEREFORE, for and in consideration of the above premises, the parties hereto
have agreed and covenanted that in consideration of the financial help to be extended by
the FIRST PARTY to the SECOND PARTY to enable the latter to resume its mining
operations in Coron, Palawan, the SECOND PARTY has agreed and undertaken as it
hereby agrees and undertakes to pay to the FIRST PARTY fifteen per centum (15%) of its
net profits." (Exh. H-2)
Pursuant to the agreement mentioned above, petitioner gave to Palawan Manganese Mines, Inc. yearly
advances starting from 1945, which advances amounted to P587,308.07 by the end of 1951. Despite these
advances and the resumption of operations by Palawan Manganese Mines, Inc., it continued to suffer losses.
By 1951, petitioner became convinced that those advances could no longer be recovered. While it continued
to give advances, it decided to write off as worthless the sum of P353,134.25. This amount "was arrived at on
the basis of the total of advances made from 1945 to 1949 in the sum of P438,981.39, from which amount the
sum of P85,647.14 had to be deducted, the latter sum representing its pre-war assets. (t.s.n., pp. 136-
139, Id)." (Page 4, Memorandum for Petitioner.) Petitioner decided to maintain the advances given in 1950
and 1951 in the hope that it might be able to recover the same, as in fact it continued to give advances up to
1952. From these facts, and as admitted by petitioner itself, Palawan Manganese Mines, Inc., was still in
operation when the advances corresponding to the years 1945 to 1949 were written off the books of petitioner.
Under the circumstances, was the sum of P353,134.25 properly claimed by petitioner as deduction in its
income tax return for 1951, either as losses or bad debts?
It will be noted that in giving advances to Palawan Manganese Mine Inc., petitioner did not expect to be
repaid. It is true that some testimonial evidence was presented to show that there was some agreement that
the advances would be repaid, but no documentary evidence was presented to this effect. The memorandum
agreement signed by the parties appears to be very clear that the consideration for the advances made by
petitioner was 15% of the net profits of Palawan Manganese Mines, Inc. In other words, if there were no
earnings or profits, there was no obligation to repay those advances. It has been held that the voluntary
advances made without expectation of repayment do not result in deductible losses. 1955 PH Fed. Taxes,
Par. 13, 329, citing W. F. Young, Inc. v. Comm.,  120 F 2d. 159, 27 AFTR 395; George B. Markle, 17 TC.
1593.
Is the said amount deductible as a bad debt? As already stated, petitioner gave advances to Palawan
Manganese Mines, Inc., without expectation of repayment. Petitioner could not sue for recovery under the
memorandum agreement because the obligation of Palawan Manganese Mines, Inc. was to pay petitioner
15% of its net profits, not the advances. No bad debt could arise where there is no valid and subsisting debt.
Again, assuming that in this case there was a valid and subsisting debt and that the debtor was incapable of
paying the debt in 1951, when petitioner wrote off the advances and deducted the amount in its return for said
year, yet the debt is not deductible in 1951 as a worthless debt. It appears that the debtor was still in operation
in 1951 and 1952, as petitioner continued to give advances in those years. It has been held that if the debtor
corporation, although losing money or insolvent, was still operating at the end of the taxable year, the debt is
not considered worthless and therefore not deductible. 3
The Tax Court's disallowance of the write-off was proper. The Solicitor General has rightly pointed out that the
taxpayer has taken an "ambiguous position " and "has not definitely taken a stand on whether the amount
involved is claimed as losses or as bad debts but insists that it is either a loss or a bad debt."  4 We sustain the
government's position that the advances made by the taxpayer to its 100% subsidiary, Palawan Manganese
Mines, Inc. amounting to P587,308,07 as of 1951 were investments and not loans. 5 The evidence on record
shows that the board of directors of the two companies since August, 1945, were identical and that the only
capital of Palawan Manganese Mines, Inc. is the amount of P100,000.00 entered in the taxpayer's balance
sheet as its investment in its subsidiary company. 6 This fact explains the liberality with which the taxpayer
made such large advances to the subsidiary, despite the latter's admittedly poor financial condition.
The taxpayer's contention that its advances were loans to its subsidiary as against the Tax Court's finding that
under their memorandum agreement, the taxpayer did not expect to be repaid, since if the subsidiary had no
earnings, there was no obligation to repay those advances, becomes immaterial, in the light of our resolution
of the question. The Tax Court correctly held that the subsidiary company was still in operation in 1951 and
1952 and the taxpayer continued to give it advances in those years, and, therefore, the alleged debt or
investment could not properly be considered worthless and deductible in 1951, as claimed by the taxpayer.
Furthermore, neither under Section 30 (d) (2) of our Tax Code providing for deduction by corporations of
losses actually sustained and charged off during the taxable year nor under Section 30 (e) (1) thereof
providing for deduction of bad debts actually ascertained to be worthless and charged off within the taxable
year, can there be a partial writing off of a loss or bad debt, as was sought to be done here by the taxpayer.
For such losses or bad debts must be ascertained to be so and written off during the taxable year, are
therefore deductible in full or not at all, in the absence of any express provision in the Tax Code authorizing
partial deductions.
The Tax Court held that the taxpayer's loss of its investment in its subsidiary could not be deducted for the
year 1951, as the subsidiary was still in operation in 1951 and 1952. The taxpayer, on the other hand, claims
that its advances were irretrievably lost because of the staggering losses suffered by its subsidiary in 1951
and that its advances after 1949 were "only limited to the purpose of salvaging whatever ore was already
available, and for the purpose of paying the wages of the laborers who needed help." 7 The correctness of the
Tax Court's ruling in sustaining the disallowance of the write-off in 1951 of the taxpayer's claimed losses is
borne out by subsequent events shown in Cases L-24972 and L-24978 involving the taxpayer's 1957 income
tax liability. (Infra, paragraph 6.) It will there be seen that by 1956, the obligation of the taxpayer's subsidiary to
it had been reduced from P587,398.97 in 1951 to P442,885.23 in 1956, and that it was only on January 1,
1956 that the subsidiary decided to cease operations. 8
(c) Disallowance of losses in Balamban Coal Mines (1950 and 1951). — The Court sustains the Tax Court's
disallowance of the sums of P8,989.76 and P27,732.66 spent by the taxpayer for the operation of its
Balamban coal mines in Cebu in 1950 and 1951, respectively, and claimed as losses in the taxpayer's returns
for said years. The Tax Court correctly held that the losses "are deductible in 1952, when the mines were
abandoned, and not in 1950 and 1951, when they were still in operation." 9 The taxpayer's claim that these
expeditions should be allowed as losses for the corresponding years that they were incurred, because it made
no sales of coal during said years, since the promised road or outlet through which the coal could be
transported from the mines to the provincial road was not constructed, cannot be sustained. Some definite
event must fix the time when the loss is sustained, and here it was the event of actual abandonment of the
mines in 1952. The Tax Court held that the losses, totalling P36,722.42 were properly deductible in 1952, but
the appealed judgment does not show that the taxpayer was credited therefor in the determination of its tax
liability for said year. This additional deduction of P36,722.42 from the taxpayer's taxable income in 1952
would result in the elimination of the deficiency tax liability for said year in the sum of P3,600.00 as determined
by the Tax Court in the appealed judgment.
(d) and (e) Allowance of losses in Hacienda Dalupiri (1950 to 1954) and Hacienda Samal (1951-1952). — The
Tax Court overruled the Commissioner's disallowance of these items of losses thus:
Petitioner deducted losses in the operation of its Hacienda Dalupiri the sums of P17,418.95 in 1950,
P29,125.82 in 1951, P26,744.81 in 1952, P21,932.62 in 1953, and P42,938.56 in 1954. These
deductions were disallowed by respondent on the ground that the farm was operated solely for
pleasure or as a hobby and not for profit. This conclusion is based on the fact that the farm was
operated continuously at a loss. 1awphîl.nèt
From the evidence, we are convinced that the Hacienda Dalupiri was operated by petitioner for
business and not pleasure. It was mainly a cattle farm, although a few race horses were also raised.
 It does not appear that the farm was used by petitioner for entertainment, social activities, or other
non-business purposes. Therefore, it is entitled to deduct expenses and losses in connection with the
operation of said farm. (See 1955 PH Fed. Taxes, Par. 13, 63, citing G.C.M. 21103, CB 1939-1,
p.164)
Section 100 of Revenue Regulations No. 2, otherwise known as the Income Tax Regulations,
authorizes farmers to determine their gross income on the basis of inventories. Said regulations
provide:
"If gross income is ascertained by inventories, no deduction can be made for livestock or
products lost during the year, whether purchased for resale, produced on the farm, as such
losses will be reflected in the inventory by reducing the amount of livestock or products on
hand at the close of the year."
Evidently, petitioner determined its income or losses in the operation of said farm on the basis of
inventories. We quote from the memorandum of counsel for petitioner:
"The Taxpayer deducted from its income tax returns for the years from 1950 to 1954
inclusive, the corresponding yearly losses sustained in the operation of Hacienda Dalupiri,
which losses represent the excess of its yearly expenditures over the receipts; that is, the
losses represent the difference between the sales of livestock and the actual cash
disbursements or expenses." (Pages 21-22, Memorandum for Petitioner.)
As the Hacienda Dalupiri was operated by petitioner for business and since it sustained losses in its
operation, which losses were determined by means of inventories authorized under Section 100 of
Revenue Regulations No. 2, it was error for respondent to have disallowed the deduction of said
losses. The same is true with respect to loss sustained in the operation of the Hacienda Samal for
the years 1951 and 1952. 10
The Commissioner questions that the losses sustained by the taxpayer were properly based on the inventory
method of accounting. He concedes, however, "that the regulations referred to does not specify how the
inventories are to be made. The Tax Court, however, felt satisfied with the evidence presented by the
taxpayer ... which merely consisted of an alleged physical count of the number of the livestock in Hacienda
Dalupiri for the years involved." 11 The Tax Court was satisfied with the method adopted by the taxpayer as a
farmer breeding livestock, reporting on the basis of receipts and disbursements. We find no Compelling
reason to disturb its findings.
2. Disallowance of excessive depreciation of buildings (1950-1954). — During the years 1950 to 1954, the
taxpayer claimed a depreciation allowance for its buildings at the annual rate of 10%. The Commissioner
claimed that the reasonable depreciation rate is only 3% per annum, and, hence, disallowed as excessive the
amount claimed as depreciation allowance in excess of 3% annually. We sustain the Tax Court's finding that
the taxpayer did not submit adequate proof of the correctness of the taxpayer's claim that the depreciable
assets or buildings in question had a useful life only of 10 years so as to justify its 10% depreciation per
annum claim, such finding being supported by the record. The taxpayer's contention that it has many zero or
one-peso assets, 12 representing very old and fully depreciated assets serves but to support the
Commissioner's position that a 10% annual depreciation rate was excessive.
3. Taxable increase in net worth (1950-1951). — The Tax Court set aside the Commissioner's treatment as
taxable income of certain increases in the taxpayer's net worth. It found that:
For the year 1950, respondent determined that petitioner had an increase in net worth in the sum of
P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated by
respondent as taxable income of petitioner for said years.
It appears that petitioner had an account with the Manila Insurance Company, the records bearing on
which were lost. When its records were reconstituted the amount of P349,800.00 was set up as its
liability to the Manila Insurance Company. It was discovered later that the correct liability was only
319,750.00, or a difference of P30,050.00, so that the records were adjusted so as to show the
correct liability. The correction or adjustment was made in 1950. Respondent contends that the
reduction of petitioner's liability to Manila Insurance Company resulted in the increase of petitioner's
net worth to the extent of P30,050.00 which is taxable. This is erroneous. The principle underlying
the taxability of an increase in the net worth of a taxpayer rests on the theory that such an increase in
net worth, if unreported and not explained by the taxpayer, comes from income derived from a
taxable source. (See Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L-
11534 & L-11558, Nov. 25, 1958.) In this case, the increase in the net worth of petitioner for 1950 to
the extent of P30,050.00 was not the result of the receipt by it of taxable income. It was merely the
outcome of the correction of an error in the entry in its books relating to its indebtedness to the
Manila Insurance Company. The Income Tax Law imposes a tax on income; it does not tax any or
every increase in net worth whether or not derived from income. Surely, the said sum of P30,050.00
was not income to petitioner, and it was error for respondent to assess a deficiency income tax on
said amount.
The same holds true in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum
of P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in petitioner's books as
outstanding liabilities of trade creditors. These accounts were discovered in 1951 as having been paid in prior
years, so that the necessary adjustments were made to correct the errors. If there was an increase in net
worth of the petitioner, the increase in net worth was not the result of receipt by petitioner of taxable
income." 13 The Commissioner advances no valid grounds in his brief for contesting the Tax Court's findings.
Certainly, these increases in the taxpayer's net worth were not taxable increases in net worth, as they were
not the result of the receipt by it of unreported or unexplained taxable income, but were shown to be merely
the result of the correction of errors in its entries in its books relating to its indebtednesses to certain creditors,
which had been erroneously overstated or listed as outstanding when they had in fact been duly paid. The Tax
Court's action must be affirmed.
4. Gain realized from sale of real property (1950). — We likewise sustain as being in accordance with the
evidence the Tax Court's reversal of the Commissioner's assessment on all alleged unreported gain in the
sum of P11,147.26 in the sale of a certain real property of the taxpayer in 1950. As found by the Tax Court,
the evidence shows that this property was acquired in 1926 for P11,852.74, and was sold in 1950 for
P60,000.00, apparently, resulting in a gain of P48,147.26. 14 The taxpayer reported in its return a gain of
P37,000.00, or a discrepancy of P11,147.26. 15 It was sufficiently proved from the taxpayer's books that after
acquiring the property, the taxpayer had made improvements totalling P11,147.26, 16 accounting for the
apparent discrepancy in the reported gain. In other words, this figure added to the original acquisition cost of
P11,852.74 results in a total cost of P23,000.00, and the gain derived from the sale of the property for
P60,000.00 was correctly reported by the taxpayer at P37,000.00.
On the second issue of prescription, the taxpayer's contention that the Commissioner's action to recover its
tax liability should be deemed to have prescribed for failure on the part of the Commissioner to file a complaint
for collection against it in an appropriate civil action, as contradistinguished from the answer filed by the
Commissioner to its petition for review of the questioned assessments in the case a quo has long been
rejected by this Court. This Court has consistently held that "a judicial action for the collection of a tax is
begun by the filing of a complaint with the proper court of first instance, or where the assessment is appealed
to the Court of Tax Appeals, by filing an answer to the taxpayer's petition for review wherein payment of the
tax is prayed for." 17 This is but logical for where the taxpayer avails of the right to appeal the tax assessment
to the Court of Tax Appeals, the said Court is vested with the authority to pronounce judgment as to the
taxpayer's liability to the exclusion of any other court. In the present case, regardless of whether the
assessments were made on February 24 and 27, 1956, as claimed by the Commissioner, or on December 27,
1955 as claimed by the taxpayer, the government's right to collect the taxes due has clearly not prescribed, as
the taxpayer's appeal or petition for review was filed with the Tax Court on May 4, 1960, with the
Commissioner filing on May 20, 1960 his Answer with a prayer for payment of the taxes due, long before the
expiration of the five-year period to effect collection by judicial action counted from the date of assessment.
Cases L-24972 and L-24978
These cases refer to the taxpayer's income tax liability for the year 1957. Upon examination of its
corresponding income tax return, the Commissioner assessed it for deficiency income tax in the amount of
P38,918.76, computed as follows:
Net income per return P29,178.70
Add: Unallowable deductions:
(1) Net loss claimed on Ha. Dalupiri 89,547.33
(2) Amortization of Contractual right claimed as an expense
under Mines Operations 48,481.62
Net income per investigation P167,297.65
Tax due thereon 38,818.00
Less: Amount already assessed 5,836.00
Balance P32,982.00
Add:           1/2% monthly interest from 6-20-59 to 6-20-62 5,936.76
TOTAL AMOUNT DUE AND COLLECTIBLE P38,918.76 18
The Tax Court overruled the Commissioner's disallowance of the taxpayer's losses in the operation of its
Hacienda Dalupiri in the sum of P89,547.33 but sustained the disallowance of the sum of P48,481.62, which
allegedly represented 1/5 of the cost of the "contractual right" over the mines of its subsidiary, Palawan
Manganese Mines, Inc. which the taxpayer had acquired. It found the taxpayer liable for deficiency income tax
for the year 1957 in the amount of P9,696.00, instead of P32,982.00 as originally assessed, and rendered the
following judgment:
WHEREFORE, the assessment appealed from is hereby modified. Petitioner is hereby ordered to
pay to respondent the amount of P9,696.00 as deficiency income tax for the year 1957, plus the
corresponding interest provided in Section 51 of the Revenue Code. If the deficiency tax is not paid
in full within thirty (30) days from the date this decision becomes final and executory, petitioner shall
pay a surcharge of five per cent (5%) of the unpaid amount, plus interest at the rate of one per cent
(1%) a month, computed from the date this decision becomes final until paid, provided that the
maximum amount that may be collected as interest shall not exceed the amount corresponding to a
period of three (3) years. Without pronouncement as to costs. 19
Both parties again appealed from the respective adverse rulings against them in the Tax Court's decision.
5. Allowance of losses in Hacienda Dalupiri (1957). — The Tax Court cited its previous decision overruling the
Commissioner's disallowance of losses suffered by the taxpayer in the operation of its Hacienda Dalupiri,
since it was convinced that the hacienda was operated for business and not for pleasure. And in this appeal,
the Commissioner cites his arguments in his appellant's brief in Case No. L-21557. The Tax Court, in setting
aside the Commissioner's principal objections, which were directed to the accounting method used by the
taxpayer found that:
It is true that petitioner followed the cash basis method of reporting income and expenses in the
operation of the Hacienda Dalupiri and used the accrual method with respect to its mine operations.
This method of accounting, otherwise known as the hybrid method, followed by petitioner is not
without justification.
... A taxpayer may not, ordinarily, combine the cash and accrual bases. The 1954 Code
provisions permit, however, the use of a hybrid method of accounting, combining a cash
and accrual method, under circumstances and requirements to be set out in Regulations to
be issued. Also, if a taxpayer is engaged in more than one trade or business he may use a
different method of accounting for each trade or business. And a taxpayer may report
income from a business on accrual basis and his personal income on the cash basis.' (See
Mertens, Law of Federal Income Taxation, Zimet & Stanley Revision, Vol. 2, Sec. 12.08, p.
26.) 20
The Tax Court, having satisfied itself with the adequacy of the taxpayer's accounting method and
procedure as properly reflecting the taxpayer's income or losses, and the Commissioner having
failed to show the contrary, we reiterate our ruling [supra, paragraph 1 (d) and (e)] that we find no
compelling reason to disturb its findings.
6. Disallowance of amortization of alleged "contractual rights." — The reasons for sustaining this disallowance
are thus given by the Tax Court:
It appears that the Palawan Manganese Mines, Inc., during a special meeting of its Board of
Directors on January 19, 1956, approved a resolution, the pertinent portions of which read as follows:
"RESOLVED, as it is hereby resolved, that the corporation's current assets composed of
ores, fuel, and oil, materials and supplies, spare parts and canteen supplies appearing in
 the inventory and balance sheet of the Corporation as of December 31, 1955, with an
aggregate value of P97,636.98, contractual rights for the operation of various mining claims
in Palawan with a value of P100,000.00, its title on various mining claims in Palawan with a
value of P142,408.10 or a total value of P340,045.02 be, as they are hereby ceded and
transferred to Fernandez Hermanos, Inc., as partial settlement of the indebtedness of the
corporation to said Fernandez Hermanos Inc. in the amount of P442,895.23." (Exh. E, p. 17,
CTA rec.)
On March 29, 1956, petitioner's corporation accepted the above offer of transfer, thus:
"WHEREAS, the Palawan Manganese Mines, Inc., due to its yearly substantial losses has
decided to cease operation on January 1, 1956 and in order to satisfy at least a part of its
indebtedness to the Corporation, it has proposed to transfer its current assets in the amount
of NINETY SEVEN THOUSAND SIX HUNDRED THIRTY SIX PESOS & 98/100
(P97,636.98) as per its balance sheet as of December 31, 1955, its contractual rights
valued at ONE HUNDRED THOUSAND PESOS (P100,000.00) and its title over various
mining claims valued at ONE HUNDRED FORTY TWO THOUSAND FOUR HUNDRED
EIGHT PESOS & 10/100 (P142,408.10) or a total evaluation of THREE HUNDRED FORTY
THOUSAND FORTY FIVE PESOS & 08/100 (P340,045.08) which shall be applied in partial
settlement of its obligation to the Corporation in the amount of FOUR HUNDRED FORTY
TWO THOUSAND EIGHT HUNDRED EIGHTY FIVE PESOS & 23/100 (P442,885.23),"
(Exh. E-1, p. 18, CTA rec.)
Petitioner determined the cost of the mines at P242,408.10 by adding the value of the contractual
rights (P100,000.00) and the value of its mining claims (P142,408.10). Respondent disallowed the
deduction on the following grounds: (1) that the Palawan Manganese Mines, Inc. could not transfer
P242,408.10 worth of assets to petitioner because the balance sheet of the said corporation for 1955
shows that it had only current as worth P97,636.96; and (2) that the alleged amortization of
"contractual rights" is not allowed by the Revenue Code.
The law in point is Section 30(g) (1) (B) of the Revenue Code, before its amendment by Republic Act
No. 2698, which provided in part:
"(g) Depletion of oil and gas wells and mines.:
"(1) In general. — ... (B) in the case of mines, a reasonable allowance for depletion thereof
not to exceed the market value in the mine of the product thereof, which has been mined
and sold during the year for which the return and computation are made. The allowances
shall be made under rules and regulations to be prescribed by the Secretary of
Finance: Provided, That when the allowances shall equal the capital invested, ... no further
allowance shall be made."
Assuming, arguendo, that the Palawan Manganese Mines, Inc. had assets worth P242,408.10 which
it actually transferred to the petitioner in 1956, the latter cannot just deduct one-fifth (1/5) of said
amount from its gross income for the year 1957 because such deduction in the form of depletion
charge was not sanctioned by Section 30(g) (1) (B) of the Revenue Code, as above-quoted.
xxx     xxx     xxx
The sole basis of petitioner in claiming the amount of P48,481.62 as a deduction was the
memorandum of its mining engineer (Exh. 1, pp. 31-32, CTA rec.), who stated that the ore reserves
of the Busuange Mines (Mines transferred by the Palawan Manganese Mines, Inc. to the petitioner)
would be exhausted in five (5) years, hence, the claim for P48,481.62 or one-fifth (1/5) of the alleged
cost of the mines corresponding to the year 1957 and every year thereafter for a period of 5 years.
The said memorandum merely showed the estimated ore reserves of the mines and it probable
selling price. No evidence whatsoever was presented to show the produced mine and for how much
they were sold during the year for which the return and computation were made. This is necessary in
order to determine the amount of depletion that can be legally deducted from petitioner's gross
income. The method employed by petitioner in making an outright deduction of 1/5 of the cost of the
mines is not authorized under Section 30(g) (1) (B) of the Revenue Code. Respondent's
disallowance of the alleged "contractual rights" amounting to P48,481.62 must therefore be
sustained. 21
The taxpayer insists in this appeal that it could use as a method for depletion under the pertinent provision of
the Tax Code its "capital investment," representing the alleged value of its contractual rights and titles to
mining claims in the sum of P242,408.10 and thus deduct outright one-fifth (1/5) of this "capital investment"
every year. regardless of whether it had actually mined the product and sold the products. The very authorities
cited in its brief give the correct concept of depletion charges that they "allow for the exhaustion of the capital
value of the deposits by production"; thus, "as the cost of the raw materials must be deducted from the gross
income before the net income can be determined, so the estimated cost of the reserve used up is
allowed." 22 The alleged "capital investment" method invoked by the taxpayer is not a method of depletion, but
the Tax Code provision, prior to its amendment by Section 1, of Republic Act No. 2698, which took effect on
June 18, 1960, expressly provided that "when the allowances shall equal the capital invested ... no further
allowances shall be made;" in other words, the "capital investment" was but the limitation of the amount of
depletion that could be claimed. The outright deduction by the taxpayer of 1/5 of the cost of the mines, as if it
were a "straight line" rate of depreciation, was correctly held by the Tax Court not to be authorized by the Tax
Code.
ACCORDINGLY, the judgment of the Court of Tax Appeals, subject of the appeals in Cases Nos. L-21551
and L-21557, as modified by the crediting of the losses of P36,722.42 disallowed in 1951 and 1952 to the
taxpayer for the year 1953 as directed in paragraph 1 (c) of this decision, is hereby affirmed. The judgment of
the Court of Tax Appeals appealed from in Cases Nos. L-24972 and L-24978 is affirmed in toto. No costs. So
ordered.
.