CIR vs. Filinvest Dev’t Corp.

G.R. 163653 ; July 19, 2011

Facts:

Filinvest Development Corp (FDC) is the owner of outstanding shares of both Filinvest Alabang,
Inc. (FAI) and Filinvest Land, Inc. (FLI) with 80% and 67.42%, respectively. Sometime in 1996,
FDC and FAI entered into a Deed of Exchange with FLI where both transferred parcels of land in
exchange for shares of stocks of FLI. As a result, the ownership structure of FLI changed
whereby FDC’s ownership decreased from 67.42% to 61.03% meanwhile FAI now owned 9.96%
of shares of FLI. FLI then requested from the BIR a ruling to the effect that no gain or loss should
be recognized on said transfer and BIR issued Ruling No. S-34-046-97 finding the exchange
falling within Sec. 34 (c) (2) (now Sec. 40 (c)(2)) of the NIRC. Furthermore, FDC extended
advances in favor of its affiliates during 1996 and 1997 duly evidenced by instructional letters as
well as cash and journal vouchers. Moreover, FDC also entered into a shareholder’s agreement
with Reco-Herrera PTE ltd. (RHPL) for the formation of a Singapore-based joint venture
company called Filinvest Asia Corp. (FAC). The equity participation of FDC was pegged at 60%
subscribing to P500.7M worth of shares of FAC.

On Jan 3, 2000, FDC received assessment notices for deficiency income tax and deficiency
stamp taxes. The foregoing deficiency taxes were assessed on the taxable gain realized by FDC
on the taxable gain supposedly realized by FDC from the Deed of Exchange it executed with FAI
and FLI, on the dilution resulting from the shareholder’s agreement FDC executed with RHPL
and with the interest rate and documentary stamp taxes imposable on the advances executed
by FDC. FAI also received similar assessment on deficiency income tax relating to the deed of
exchange. Both FDC and FAI protested and after having failed to act on their protest they
docketed their case with the CTA. They raised the issue that pursuant to BIR Ruling No. S-34-
046-97, no taxable gain should have been assessed from the deed of exchange and that the BIR
cannot impute theoretical interests on the cash advances of FDC in the absence of stipulation
and that not being promissory notes such are not subject to documentary stamp taxes. CIR, for
its part, raised that the said transfer of property resulted to a diminution of ownership by FDC
of FLI rather than gaining further control and as such should not be tax free. Furthermore, CIR
invoked Sec. 43 (now Sec. 50) of NIRC as implemented by RR No. 2, the CIR is given the "the
power to allocate, distribute or apportion income or deductions between or among such
organizations, trades or business in order to prevent evasion of taxes." Also the CIR justified the
imposition of documentary stamp taxes on the instructional letters citing Sec. 180 of the NIRC
and RR No. 9-94 which provide that loan transactions are subject to tax irrespective of whether
or not they are evidenced by a formal agreement or by mere office memo. Lastly, it reiterated
that there was dilution of its shares as a result of its shareholder’s agreement with RHPL. CTA
decided in favor of FDC with the exception on the deficiency income tax on the interest income
from the income it supposedly realized from the advances to its affiliates, the rest of the
assessment were cancelled. The CTA opined that CIR was justified in assessing undeclared
interests on the same cash advances pursuant to his authority under Section 43 of the NIRC in
order to forestall tax evasion. Dissatisfied, FDC filed a petition for review with the Court of
Appeals claiming that the cash advances it extended to its affiliates were interest-free in the
absence of express stipulation. Moreover, it claimed that under Sec. 43 (now Sec. 50) the CIR’s
authority does not include the power to impute imaginary interests, directed only to controlled
corp and not to holding company and can be invoked only on cases of understatement of
taxable income or evident tax evasion. The CA rendered a decision in favor of FDC cancelling
said assessment. The CIR filed a petition for review with the CA which subsequently denied for
lack of merit. The CA has the following conclusions: 1. The deed of exchange resulted in a
combined control of more than 51% of FLI , hance no taxable gain; 2. The instructional letters
do not partake the nature of loan agreements; 3. Although subsequently modified by BIR Ruling
No. 108-99 to the effect that documentary stamp tax are now imposable on interoffice memos,
to give a retroactive application would be prejudicial to the taxpayer.; 4. FDC’s alleged gain
from the increase of its shareholding in FAC are mere unrealized increase in capital unless
converted thru sale are not taxable. Hence, this petition for review on certiorari.

Issue:

(1) Whether or not FDC is liable for theoretical interest on said advances extended by it to its
affiliates.

(2) Whether or not FDC met all the requirements for non-recognition of taxable gain under Sec.
34 (c) (2) (now Sec. 40 (C) (2) of the NIRC and therefore, is not taxable.

(3) Whether or not the letters of instructions or cash vouchers are deemed loan agreements
subject to documentary stamp tax.

(4) Whether or not the dilution as a result of increase of FDC’s shareholding in FAC is taxable.

Held:

(1) No. Sec. 43 (now Sec. 50) of the NIRC does not include the power to impute theoretical
interest to the CIR’s powers of distribution, apportionment or allocation of gross income
and deductions. There must be proof of actual or probable receipt or realization by the
controlled taxpayer of the item of gross income sought to be distributed, apportioned or
allocated by the CIR. In the case at bar, records do not show that there was evidence
 that the advances extended yielded interests. Even if FDC deducted substantial interest
expenses from its gross income, there would still be no basis for the imputation of
theoretical interests on the subject advances. Under Art. 1956 of the Civil Code, no
interest shall be due unless it has been expressly stipulated in writing. Moreover, taxes
being burdens are not to be presumed and that tax statutes must be construed strictly
against the government and liberally in favor of the taxpayer.
(2) Yes. It was admitted in the stipulation of facts that the following are the requisites: (a)
the transferee is a corporation; (b) the transferee exchanges its shares of stock for
property/ies of the transferor; (c) the transfer is made by a person, acting alone or
together with others, not exceeding four persons; and, (d) as a result of the exchange
the transferor, alone or together with others, not exceeding four, gains control of the
transferee. Moreover, it is not taxable because the exchange did not result to a
decrease of the ownership of FDC in FLI rather combining the interests of FDC and FAI
result to 70.99% of FLI’s outstanding shares. Since the term "control" is clearly defined
as "ownership of stocks in a corporation possessing at least fifty-one percent (51%) of
the total voting power of classes of stocks entitled to one vote” then the said exchange
clearly qualify as a tax-free transaction. Therefore, both FDC and FAI cannot be held
liable for deficiency income tax on said transfer.
(3) Yes. The instructional letters as well as the journal and cash vouchers evidencing the
advances FDC extended to its affiliates in 1996 and 1997 qualified as loan agreements
upon which documentary stamp taxes may be imposed. apply them would be
prejudicial to the taxpayers. This rule does not apply: (a) where the taxpayer
deliberately misstates or omits material facts from his return or in any document
required of him by the Bureau of Internal Revenue; (b) where the facts subsequently
gathered by the Bureau of Internal Revenue are materially different from the facts on
which the ruling is based; or (c) where the taxpayer acted in bad faith. The principle of
non-retroactivity of BIR rulings does not apply in favor of FDR because it is not the
taxpayer who in the first place, sought the said BIR ruling from the CIR.

(4) No. the CIR has no factual and legal basis in assessing income tax on the increase in the
value of FDC's shareholdings in FAC until the same is actually sold at a profit. A mere
increase or appreciation in the value of said shares cannot be considered income for
taxation purposes. Besides, tax revenues should be strictly construed and that rulings of
the CTA should be accorded with respect and upheld by the Court absent any reversible
errors.