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Tax Cases Set H LT 1

G.R. No. L-65773-74 April 30, 1987 COMMISSIONER OF INTERNAL REVENUE, petitioner, vs.BRITISH OVERSEASAIRWAYS 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 isengaged in the international airline business and is a member-signatory of the Interline Air Transport Association (IATA). Assuch it operates air transportation service and sells transportation tickets over the routes of the other airline members. Duringthe periods covered by the disputed assessments, it is admitted that BOAC had no landing rights for traffic purposes in thePhilippines, 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 temporarylanding permit by the CAB. Consequently, it did not carry passengers and/or cargo to or from the Philippines, although duringthe period covered by the assessments, it maintained a general sales agent in the Philippines — Wamer Barnes andCompany, Ltd., and later Qantas Airways — which was responsible for selling BOAC tickets covering passengers andcargoes. 1

G.R. No. 65773 (CTA Case No. 2373, the First Case)P

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. Subsequentinvestigation resulted in the issuance of a new assessment, dated 16 January 1970 for the years 1959 to 1967 in the amountof 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 16February 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 1968-1969to 1970-1971 in the aggregate amount of P549,327.43, and the additional amounts of P1,000.00 and P1,800.00 ascompromise penalties for violation of Section 46 (requiring the filing of corporation returns) penalized under Section 74 of theNational 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 theSecond Case the deficiency income tax assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 ascompromise 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 theproceeds 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 carriageof passengers or freight was performed by BOAC within the Philippines" and, therefore, said income is not subject toPhilippine income tax. The CTA position was that income from transportation is income from services so that the place whereservices 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 theamount 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, constituteincome 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 businessin 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%)

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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 anoffice 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 environmentalcircumstances. The term implies a continuity of commercial dealings and arrangements, and contemplates, to that extent, theperformance 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. 2 "In order that a foreign corporation may beregarded as doing business within a State, there must be continuity of conduct and intention to establish a continuousbusiness, 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, Thatgeneral sales agent, from 1959 to 1971, "was engaged in (1) selling and issuing tickets; (2) breaking down the whole trip intoseries 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 renderedthrough the mode of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA

Agreement." 4 Those activities were in exercise of the functions which are normally incident to, and are in progressive pursuitof, 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 doubtthen that BOAC was "engaged in" business in the Philippines through a local agent during the period covered by theassessments. Accordingly, it is a resident foreign corporation subject to tax upon its total net income received in thepreceding 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 foreigncountry, except a foreign fife insurance company, engaged in trade or business within the Philippines, shallbe taxable as provided in subsection (a) of this section upon the total net income received in the precedingtaxable 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 Philippinesconstitutes 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 theownership 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 fromany source whatever (Sec. 29[3]; Emphasis supplied)

The definition is broad and comprehensive to include proceeds from sales of transport documents. "The words 'income fromany source whatever' disclose a legislative policy to include all income not expressly exempted within the class of taxableincome under our laws." Income means "cash received or its equivalent"; it is the amount of money coming to a person withina 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. 6The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to 1970-71 amounted toP10,428,368 .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. 8 For the source of income to beconsidered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. InBOAC's case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands hereand 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 thePhilippine government. In consideration of such protection, the flow of wealth should share the burden of supporting thegovernment.

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A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between theticket-holder and the carrier. It gives rise to the obligation of the purchaser of the ticket to pay the fare and the correspondingobligation of the carrier to transport the passenger upon the terms and conditions set forth thereon. The ordinary ticket issuedto 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 anincome from sources within the Philippines. Section 37, by its language, does not intend the enumeration to be exclusive. Itmerely directs that the types of income listed therein be treated as income from sources within the Philippines. A cursoryreading of the section will show that it does not state that it is an all-inclusive enumeration, and that no other kind of incomemay be so considered. " 10

BOAC, however, would impress upon this Court that income derived from transportation is income for services, with theresult that the place where the services are rendered determines the source; and since BOAC's service of transportation isperformed outside the Philippines, the income derived is from sources without the Philippines and, therefore, not taxableunder 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 incometaxation. 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. 11Unquestionably, the passage

documentations in these cases were sold in the Philippines and the revenue therefrom was derived from a activity regularlypursued within the Philippines. business a And even if the BOAC tickets sold covered the "transport of passengers and cargoto and from foreign cities", 12 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. 13

It should be pointed out, however, that the assessments upheld herein apply only to the fiscal years covered by thequestioned deficiency income tax assessments in these cases, or, from 1959 to 1967, 1968-69 to 1970-71. For, pursuant toPresidential 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 Philippinebillings. (Sec. 24[b] [21, Tax Code).

Presidential Decree No. 1355, promulgated on 21 April, 1978, provided a statutory definition of the term "gross Philippinebillings," thus:

... "Gross Philippine billings" includes gross revenue realized from uplifts anywhere in the world by anyinternational 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 % taxon gross Philippine billings is an income tax. If it had been intended as an excise or percentage tax it would have been placeunder 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 bythe 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 removingpassengers and cargo from one place to another. It purports to tax the business of transportation. 14 Being an excise tax, thesame 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 andother 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 BritishOverseas Airways Corporation (BOAC), is hereby ordered to pay the amount of P534,132.08 as deficiency income tax for thefiscal years 1968-69 to 1970-71 plus 5% surcharge, and 1% monthly interest from April 16, 1972 for a period not to exceedthree (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.Paras, Gancayco, Padilla, Bidin, Sarmiento and Cortes, JJ., concur.Fernan, J., took no part.

Separate Opinions TEEHANKEE, C.J., concurring:

I concur with the Court's majority judgment upholding the assessments of deficiency income taxes against respondent BOACfor the fiscal years 1959-1969 to 1970-1971 and therefore setting aside the appealed joint decision of respondent Court of Tax Appeals. I just wish to point out that the conflict between the majority opinion penned by Mr. Justice Feliciano as to the

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proper characterization of the taxable income derived by respondent BOAC from the sales in the Philippines of tickets foeBOAC form the issued by its general sales agent in the Philippines gas become moot after November 24, 1972. Boothopinions state that by amendment through P.D. No.69, promulgated on November 24, 1972, of section 24(b) (2) of the TaxCode providing dor the rate of income tax on foreign corporations, international carriers such as respondent BOAC, havesince then been taxed at a reduced rate of 2-½% on their gross Philippine billings. There is, therefore, no longer ant sourceof substantial conflict between the two opinions as to the present 2-½% tax on their gross Philippine billings charged against

such international carriers as herein respondent foreign corporation.

FELICIANO, J., dissenting:

With great respect and reluctance, i record my dissent from the opinion of Mme. Justice A.A. Melencio-Herrera speaking for the majority . In my opinion, the joint decision of the Court of Tax Appeals in CTA Cases Nos. 2373 and 2561, dated 26January 1983, is correct and should be affirmed.

The fundamental issue raised in this petition for review is whether the British Overseas Airways Corporation (BOAC), aforeign airline company which does not maintain any flight operations to and from the Philippines, is liable for Philippineincome taxation in respect of "sales of air tickets" in the Philippines through a general sales agent, relating to the carriage of passengers and cargo between two points both outside the Philippines.

1. The Solicitor General has defined as one of the issue in this case the question of:

2. Whether or not during the fiscal years in question 1 BOAC [was] a resident foreign corporation doingbusiness in the Philippines or [had] an office or place of business in the Philippines.

It is important to note at the outset that the answer to the above-quoted issue is not determinative of the lialibity of the BOACto Philippine income taxation in respect of the income here involved. The liability of BOAC to Philippine income taxation inrespect of such income depends, not on BOAC's status as a "resident foreign corporation" or alternatively, as a "non-residentforeign corporation," but rather on whether or not such income is derived from "source within the Philippines."

A "resident foreign corporation" or foreign corporation engaged in trade or business in the Philippines or having an office or place of business in the Philippines is subject to Philippine income taxation only in respect of income derived from sourceswithin the Philippines. Section 24 (b) (2) of the National Internal Revenue CODE ("Tax Code"), as amended by Republic ActNo. 2343, approved 20 June 1959, as it existed up to 3 August 1969, read as follows:

(2) Resident corporations. — A foreign corporation engaged in trade or business with in the Philippines(expect foreign life insurance companies) shall be taxable as provided in subsection (a) of this section.

Section 24 (a) of the Tax Code in turn provides:

Rate of tax on corporations. — (a) Tax on domestic corporations. — ... and a like tax shall be livied,

collected, and paid annually upon the total net income received in the preceeding taxable year from all sources within the Philippines by every corporation organized, authorized, or existing under the laws of any foreign country : ... . (Emphasis supplied)

Republic Act No. 6110, which took effect on 4 August 1969, made this even clearer when it amended once more Section 24(b) (2) of the Tax Code so as to read as follows:

(2) Resident Corporations. — A corporation, organized, authorized or existing under the laws of any foreigncounrty, except foreign life insurance company, engaged in trade or business within the Philippines, shallbe taxable as provided in subsection (a) of this section upon the total net income received in the precedingtaxable year from all sources within the Philippines. (Emphasis supplied)

Exactly the same rule is provided by Section 24 (b) (1) of the Tax Code upon non-resident foreign corporations. Section 24(b) (1) as amended by Republic Act No. 3825 approved 22 June 1963, read as follows:

(b) Tax on foreign corporations. — (1) Non-resident corporations. — There shall be levied, collected and

paid for each taxable year, in lieu of the tax imposed by the preceding paragraph upon the amount receivedby every foreign corporation not engaged in trade or business within the Philippines, from all sources withinthe Philippines, as interest, dividends, rents, salaries, wages, premium, annuities, compensations,remunerations, emoluments, or other fixed or determinative annual or periodical gains, profits and income atax equal to thirty per centum of such amount: provided, however, that premiums shall not includereinsurance premiums. 2

Clearly, whether the foreign corporate taxpayer is doing business in the Philippines and therefore a resident foreigncorporation, or not doing business in the Philippines and therefore a non-resident foreign corporation, it is liable to income taxonly to the extent that it derives income from sources within the Philippines. The circumtances that a foreign corporation isresident in the Philippines yields no inference that all or any part of its income is Philippine source income. Similarly, the non-resident status of a foreign corporation does not imply that it has no Philippine source income. Conversely, the receipt of Philippine source income creates no presumption that the recipient foreign corporation is a resident of the Philippines. The

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critical issue, for present purposes, is thereforewhether of not BOAC is deriving income from sources within the Philippines.

2. For purposes of income taxation, it is well to bear in mind that the "source of income" relates not to the physical sourcing of a flow of money or the physical situs of payment but rather to the "property, activity or service which produced the income."In Howden and Co., Ltd. vs. Collector of Internal Revenue, 3 the court dealt with the issue of the applicable source rulerelating to reinsurance premiums paid by a local insurance company to a foreign reinsurance company in respect of riskslocated in the Philippines. The Court said:

The source of an income is the property, activity or services that produced the income. The reinsurance premiums remitted to appellants by virtue of the reinsurance contract, accordingly, had for their source theundertaking to indemnify Commonwealth Insurance Co. against liability. Said undertaking is the activity that

produced the reinsurance premiums, and the same took place in the Philippines. — [T]he reinsurance, theliabilities insured and the risk originally underwritten by Commonwealth Insurance Co., upon which thereinsurance premiums and indemnity were based, were all situated in the Philippines. — 4

The Court may be seen to be saying that it is the underlying prestation which is properly regarded as the activity giving rise tothe income that is sought to be taxed. In the Howden case, that underlying prestation was the indemnification of the local insurance company. Such indemnification could take place only in the Philippines where the risks were located and wherepayment from the foreign reinsurance (in case the casualty insured against occurs) would be received in Philippine pesosunder the reinsurance premiums paid by the local insurance companies constituted Philippine source income of the foreignreinsurances.

The concept of "source of income" for purposes of income taxation originated in the United States income tax system. Thephrase "sources within the United States" was first introduced into the U.S. tax system in 1916, and was subsequentlyembodied in the 1939 U.S. Tax Code. As is commonly known, our Tax Code (Commonwealth Act 466, as amended) waspatterned after the 1939 U.S. Tax Code. It therefore seems useful to refer to a standard U.S. text on federal income taxation:

The Supreme Court has said, in a definition much quoted but often debated, that income may be derived from three possible sources only: (1) capital and/or (2) labor and/or (3) the sale of capital assets. While thethree elements of this attempt at definition need not be accepted as all-inclusive, they serve as usefulguides in any inquiry into whether a particular item is from "source within the United States" and suggest aninvestigation into the nature and location of the activities or property which produce the income. If theincome is from labor (services) the place where the labor is done should be decisive; if it is done in thiscounrty, the income should be from "source within the United States." If the income is from capital, the

place where the capital is employed should be decisive; if it is employed in this country, the income shouldbe from "source within the United States". If the income is from the sale of capital assets, the place wherethe sale is made should be likewise decisive. Much confusion will be avoided by regarding the term"source" in this fundamental light. It is not a place; it is an activity or property. As such, it has a situs or

location; and if that situs or location is within the United States the resulting income is taxable tononresident aliens and foreign corporations. The intention of Congress in the 1916 and subsequentstatutes was to discard the 1909 and 1913 basis of taxing nonresident aliens and foreign corporationsand to make the test of taxability the "source", or situs of the activities or property which produce theincome . . . . Thus, if income is to taxed, the recipient thereof must be resident within the jurisdiction, or the

property or activities out of which the income issue or is derived must be situated within the jurisdiction sothat the source of the income may be said to have a situs in this country. The underlying theory is that theconsideration for taxation is protection of life and property and that the income rightly to be levied upon todefray the burdens of the United States Government is that income which is created by activities and

property protected by this Government or obtained by persons enjoying that protection. 5

3. We turn now to the question what is the source of income rule applicable in the instant case. There are two possiblyrelevant source of income rules that must be confronted; (a) the source rule applicable in respect of contracts of service; and(b) the source rule applicable in respect of sales of personal property.

Where a contract for the rendition of service is involved, the applicable source rule may be simply stated as follows: theincome is sourced in the place where the service contracted for is rendered. Section 37 (a) (3) of our Tax Code reads asfollows:

Section 37. Income for sources within the Philippines.

(a) Gross income from sources within the Philippines. — The following items of gross income shall betreated as gross income from sources within the Philippines:

xxx xxx xxx

(3) Services. — Compensation for labor or personal services performed in thePhilippines;... (Emphasis supplied)

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Section 37 (c) (3) of the Tax Code, on the other hand, deals with income from sources without the Philippines in the followingmanner:

(c) Gross income from sources without the Philippines . — The following items of gross income shall betreated as income from sources without the Philippines:

(3) Compensation for labor or personal services performed without the Philippines; ... (Emphasis supplied)

It should not be supposed that Section 37 (a) (3) and (c) (3) of the Tax Code apply only in respect of services rendered byindividual natural persons; they also apply to services rendered by or through the medium of a juridical person. 6 Further, acontract of carriage or of transportation is assimilated in our Tax Code and Revenue Regulations to a contract for services.Thus, Section 37 (e) of the Tax Code provides as follows:

(e) Income form sources partly within and partly without the Philippines. — Items of gross income,expenses, losses and deductions, other than those specified in subsections (a) and (c) of this section shallbe allocated or apportioned to sources within or without the Philippines, under the rules and regulationsprescribed by the Secretary of Finance. ... Gains, profits, and income from (1)transportation or other services rendered partly within and partly without the Philippines, or (2) from the sale of personnel propertyproduced (in whole or in part) by the taxpayer within and sold without the Philippines, or produced (in wholeor in part) by the taxpayer without and sold within the Philippines, shall be treated as derived partly fromsources within and partly from sources without the Philippines. ... (Emphasis supplied)

It should be noted that the above underscored portion of Section 37 (e) was derived from the 1939 U.S. Tax Code which "was

based upon a recognition that transportation was a service and that the source of the income derived therefrom was to betreated as being the place where the service of transportation was rendered . 7

Section 37 (e) of the Tax Code quoted above carries a strong well-nigh irresistible, implication that income derived fromtransportation or other services rendered entirely outside the Philippines must be treated as derived entirely from sourceswithout the Philippines. This implication is reinforced by a consideration of certain provisions of Revenue Regulations No. 2entitled "Income Tax Regulations" as amended, first promulgated by the Department of Finance on 10 February 1940.Section 155 of Revenue Regulations No. 2 (implementing Section 37 of the Tax Code) provides in part as follows:

Section 155. Compensation for labor or personnel services. — Gross income from sources within thePhilippines includes compensation for labor or personal services within the Philippines regardless of theresidence of the payer, of the place in which the contract for services was made, or of the place of

payment — (Emphasis supplied)

Section 163 of Revenue Regulations No. 2 (still relating to Section 37 of the Tax Code) deals with a particular species of foreign transportation companies — i.e., foreign steamship companies deriving income from sources partly within and partly

without the Philippines:

Section 163 Foreign steamship companies. — The return of foreign steamship companies whose vesselstouch parts of the Philippines should include as gross income, the total receipts of all out-going business whether freight or passengers. With the gross income thus ascertained, the ratio existing betweenit and the gross income from all ports, both within and without the Philippines of all vessels, whether touching of the Philippines or not, should be determined as the basis upon which allowable deductions maybe computed, — . (Emphasis supplied)

Another type of utility or service enterprise is dealt with in Section 164 of Revenue Regulations No. 2 (again implementingSection 37 of the Tax Code) with provides as follows:

Section 164. Telegraph and cable services. — A foreign corporation carrying on the business of transmission of telegraph or cable messages between points in the Philippines and points outside thePhilippines derives income partly form source within and partly from sources without the Philippines.

... (Emphasis supplied)Once more, a very strong inference arises under Sections 163 and 164 of Revenue Regulations No. 2 that steamship andtelegraph and cable services rendered between points both outside the Philippines give rise to income wholly from sourcesoutside the Philippines, and therefore not subject to Philippine income taxation.

We turn to the "source of income" rules relating to the sale of personal property, upon the one hand, and to the purchase andsale of personal property, upon the other hand.

We consider first sales of personal property. Income from the sale of personal property by the producer or manufacturer of such personal property will be regarded as sourced entirely within or entirely without the Philippines or as sourced partly within and partly without the Philippines, depending upon two factors: (a) the place where the sale of such personal propertyoccurs; and (b) the place where such personal property was produced or manufactured. If the personal property involved wasboth produced or manufactured and sold outside the Philippines, the income derived therefrom will be regarded as sourced

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entirely outside the Philippines, although the personal property had been produced outside the Philippines, or if the sale of the property takes place outside the Philippines and the personal was produced in the Philippines, then, the income derivedfrom the sale will be deemed partly as income sourced without the Philippines. In other words, the income (and the relatedexpenses, losses and deductions) will be allocated between sources within and sources without the Philippines. Thus,Section 37 (e) of the Tax Code, although already quoted above, may be usefully quoted again:

(e) Income from sources partly within and partly without the Philippines. ... Gains, profits and income from(1) transportation or other services rendered partly within and partly without the Philippines; or (2) from thesale of personal property produced (in whole or in part) by the taxpayer within and sold without thePhilippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines, shallbe treated as derived partly from sources within and partly from sources without the Philippines. ...(Emphasis supplied)

In contrast, income derived from the purchase and sale of personal property — i. e., trading — is, under the Tax Code,regarded as sourced wholly in the place where the personal property is sold. Section 37 (e) of the Tax Code provides in partas follows:

(e) Income from sources partly within and partly without the Philippines ... Gains, profits and incomederived from the purchase of personal property within and its sale without the Philippines or from the

purchase of personal property without and its sale within the Philippines, shall be treated as derived entirely from sources within the country in which sold. (Emphasis supplied)

Section 159 of Revenue Regulations No. 2 puts the applicable rule succinctly:

Section 159. Sale of personal property. Income derived from the purchase and sale of personal property shall be treated as derived entirely from the country in which sold. The word "sold" includes "exchange."The "country" in which "sold" ordinarily means the place where the property is marketed. This Section doesnot apply to income from the sale personal property produced (in whole or in part) by the taxpayer withinand sold without the Philippines or produced (in whole or in part) by the taxpayer without and sold withinthe Philippines. (See Section 162 of these regulations). (Emphasis supplied)

4. It will be seen that the basic problem is one of characterization of the transactions entered into by BOAC in the Philippines.Those transactions may be characterized either as sales of personal property (i. e., " sales of airline tickets") or as entering into a lease of services or a contract of service or carriage. The applicable "source of income" rules differ depending uponwhich characterization is given to the BOAC transactions.

The appropriate characterization, in my opinion, of the BOAC transactions is that of entering into contracts of service, i.e.,carriage of passengers or cargo between points located outside the Philippines.

The phrase "sale of airline tickets," while widely used in popular parlance, does not appear to be correct as a matter of taxlaw. The airline ticket in and of itself has no monetary value, even as scrap paper. The value of the ticket lies wholly in theright acquired by the "purchaser" — the passenger — to demand a prestation from BOAC, which prestation consists of thecarriage of the "purchaser" or passenger from the one point to another outside the Philippines. The ticket is reallythe evidence of the contract of carriage entered into between BOAC and the passenger. The money paid by the passenger changes hands in the Philippines. But the passenger does not receive undertaken to be delivered by BOAC. The "purchaseprice of the airline ticket" is quite different from the purchase price of a physical good or commodity such as a pair of shoes of a refrigerator or an automobile; it is really the compensation paid for the undertaking of BOAC to transport the passenger or cargo outside the Philippines.

The characterization of the BOAC transactions either as sales of personal property or as purchases and sales of personalproperty, appear entirely inappropriate from other viewpoint. Consider first purchases and sales: is BOAC properly regardedas engaged in trading — in the purchase and sale of personal property? Certainly, BOAC was not purchasing tickets outsidethe Philippines and selling them in the Philippines. Consider next sales: can BOAC be regarded as "selling" personalproperty produced or manufactured by it? In a popular or journalistic sense, BOAC might be described as "selling" "a

product" — its service. However, for the technical purposes of the law on income taxation, BOAC is in fact entering intocontracts of service or carriage. The very existance of "source rules" specifically and precisely applicable to the rendition of services must preclude the application here of "source rules" applying generally to sales, and purchases and sales, of personal property which can be invoked only by the grace of popular language. On a slighty more abstract level, BOAC'sincome is more appropriately characterized as derived from a "service", rather than from an "activity" (a broader term thanservice and including the activity of selling) or from the here involved is income taxation, and not a sales tax or an excise or privilege tax.

5. The taxation of international carriers is today effected under Section 24 (b) (2) of the Tax Code, as amended byPresidential Decree No. 69, promulgated on 24 November 1972 and by Presidential Decree No. 1355, promulgated on 21

April 1978, in the following manner:

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

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country, engaged in trade or business within the Philippines, shall be taxable as provided in subsection (a)of this section upon the total net income received in the preceeding taxable year from all sources within thePhilippines: Provided, however, That international carriers shall pay a tax of two and one-half per cent ontheir gross Philippine billings. "Gross Philippines of passage documents sold therein, whether for passenger, excess baggege or mail, provide the cargo or mail originates from the Philippines. The grossrevenue realized from the said cargo or mail shall include the gross freight charge up to final destination.

Gross revenues from chartered flights originating from the Philippines shall likewise form part of "grossPhilippine billings" regardless of the place of sale or payment of the passage documents. For purposes of determining the taxability to revenues from chartered flights, the term "originating from the Philippines" shallinclude flight of passsengers who stay in the Philippines for more than forty-eight (48) hours prior toembarkation. (Emphasis supplied)

Under the above-quoted proviso international carriers issuing for compensation passage documentation in the Philippines for uplifts from any point in the world to any other point in the world, are not charged any Philippineincome tax on their Philippinebillings (i.e., billings in respect of passenger or cargo originating from the Philippines). Under this new approach, internationalcarriers who service port or points in the Philippines are treated in exactly the same way as international carriers not servingany port or point in the Philippines. Thus, the source of income rule applicable, as above discussed, to transportation or other services rendered partly within and partly without the Philippines, or wholly without the Philippines, has been set aside. inplace of Philippine income taxation, the Tax Code now imposes this 2½ per cent tax computed on the basis of billings inrespect of passengers and cargo originating from the Philippines regardless of where embarkation and debarkation would betaking place. This 2-½ per cent tax is effectively a tax on gross receipts or an excise or privilege tax and not a tax on income.

Thereby, the Government has done away with the difficulties attending the allocation of income and related expenses, lossesand deductions. Because taxes are the very lifeblood of government, the resulting potential "loss" or "gain" in the amount of taxes collectible by the state is sometimes, with varying degrees of consciousness, considered in choosing from amongcompeting possible characterizations under or interpretation of tax statutes. It is hence perhaps useful to point out that thedetermination of the appropriate characterization here — that of contracts of air carriage rather than sales of airline tickets —entails no down-the-road loss of income tax revenues to the Government. In lieu thereof, the Government takes in revenuesgenerated by the 2-½ per cent tax on the gross Philippine billings or receipts of international carriers.

I would vote to affirm the decision of the Court of Tax Appeals.

Narvasa, Gutierrez, Jr., and Cruz, JJ., dissent.

G.R. No. 159647 April 15, 2005cCOMMISSIONER OF INTERNAL REVENUE, Petitioners,vs. CENTRAL LUZON DRUG CORPORATION, Respondent. D E C I S I O N PANGANIBAN, J.:

The 20 percent discount required by the law to be given to senior citizens is a tax credit , not merely a tax deduction from thegross income or gross sale of the establishment concerned. A tax credit is used by a private establishment only after the tax

has been computed; a tax deduction, before the tax is computed. RA 7432 unconditionally grants a tax credit to all coveredentities. Thus, the provisions of the revenue regulation that withdraw or modify such grant are void. Basic is the rule thatadministrative regulations cannot amend or revoke the law.

The Case

Before us is a Petition for Review1 under Rule 45 of the Rules of Court, seeking to set aside the August 29, 2002Decision2 and the August 11, 2003 Resolution3 of the Court of Appeals (CA) in CA-GR SP No. 67439. The assailed Decisionreads as follows:

"WHEREFORE, premises considered, the Resolution appealed from is AFFIRMED in toto. No costs."4

The assailed Resolution denied petitioner’s Motion for Reconsideration.

The Facts

The CA narrated the antecedent facts as follows:

"Respondent is a domestic corporation primarily engaged in retailing of medicines and other pharmaceutical products. In1996, it operated six (6) drugstores under the business name and style ‘Mercury Drug.’

"From January to December 1996, respondent granted twenty (20%) percent sales discount to qualified senior citizens ontheir purchases of medicines pursuant to Republic Act No. [R.A.] 7432 and its Implementing Rules and Regulations. For thesaid period, the amount allegedly representing the 20% sales discount granted by respondent to qualified senior citizenstotaled P904,769.00.

"On April 15, 1997, respondent filed its Annual Income Tax Return for taxable year 1996 declaring therein that it incurred netlosses from its operations.

"On January 16, 1998, respondent filed with petitioner a claim for tax refund/credit in the amount of P904,769.00 allegedlyarising from the 20% sales discount granted by respondent to qualified senior citizens in compliance with [R.A.] 7432. Unable

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to obtain affirmative response from petitioner, respondent elevated its claim to the Court of Tax Appeals [(CTA or TaxCourt)] via a Petition for Review.

"On February 12, 2001, the Tax Court rendered a Decision5 dismissing respondent’s Petition for lack of merit. In saiddecision, the [CTA] justified its ruling with the following ratiocination:

‘x x x, if no tax has been paid to the government, erroneously or illegally, or if no amount is due and collectible from the

taxpayer, tax refund or tax credit is unavailing. Moreover, whether the recovery of the tax is made by means of a claim for refund or tax credit, before recovery is allowed[,] it must be first established that there was an actual collection and receipt bythe government of the tax sought to be recovered. x x x.

‘x x x x x x x x x

‘Prescinding from the above, it could logically be deduced that tax credit is premised on the existence of tax liability on thepart of taxpayer. In other words, if there is no tax liability, tax credit is not available.’

"Respondent lodged a Motion for Reconsideration. The [CTA], in its assailed resolution, 6 granted respondent’s motion for reconsideration and ordered herein petitioner to issue a Tax Credit Certificate in favor of respondent citing the decision of thethen Special Fourth Division of [the CA] in CA G.R. SP No. 60057 entitled ‘Central [Luzon] Drug Corporation vs.Commissioner of Internal Revenue’ promulgated on May 31, 2001, to wit:

‘However, Sec. 229 clearly does not apply in the instant case because the tax sought to be refunded or credited by petitioner was not erroneously paid or illegally collected. We take exception to the CTA’s sweeping but unfounded statement that ‘both

tax refund and tax credit are modes of recovering taxes which are either erroneously or illegally paid to the government.’ Taxrefunds or credits do not exclusively pertain to illegally collected or erroneously paid taxes as they may be other circumstances where a refund is warranted. The tax refund provided under Section 229 deals exclusively with illegallycollected or erroneously paid taxes but there are other possible situations, such as the refund of excess estimated corporatequarterly income tax paid, or that of excess input tax paid by a VAT-registered person, or that of excise tax paid on goodslocally produced or manufactured but actually exported. The standards and mechanics for the grant of a refund or creditunder these situations are different from that under Sec. 229. Sec. 4[.a)] of R.A. 7432, is yet another instance of a tax creditand it does not in any way refer to illegally collected or erroneously paid taxes, x x x.’"7

Ruling of the Court of Appeals

The CA affirmed in toto the Resolution of the Court of Tax Appeals (CTA) ordering petitioner to issue a tax credit certificate infavor of respondent in the reduced amount of P903,038.39. It reasoned that Republic Act No. (RA) 7432 required neither atax liability nor a payment of taxes by private establishments prior to the availment of a tax credit. Moreover, such credit is nottantamount to an unintended benefit from the law, but rather a just compensation for the taking of private property for publicuse.

Hence this Petition.8

The Issues

Petitioner raises the following issues for our consideration:

"Whether the Court of Appeals erred in holding that respondent may claim the 20% sales discount as a tax credit instead of as a deduction from gross income or gross sales.

"Whether the Court of Appeals erred in holding that respondent is entitled to a refund."9

These two issues may be summed up in only one: whether respondent, despite incurring a net loss, may still claim the 20percent sales discount as a tax credit.

The Court’s Ruling

The Petition is not meritorious.

Sole Issue:

Claim of 20 Percent Sales Discount

as Tax Credit Despite Net Loss

Section 4a) of RA 743210 grants to senior citizens the privilege of obtaining a 20 percent discount on their purchase of medicine from any private establishment in the country.11 The latter may then claim the cost of the discount as a tax credit .12 But can such credit be claimed, even though an establishment operates at a loss?

We answer in the affirmative.

















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Tax Credit versus

Tax Deduction

Although the term is not specifically defined in our Tax Code,13 tax credit generally refers to an amount that is "subtracteddirectly from one’s total tax liability."14 It is an "allowance against the tax itself"15 or "a deduction from what is owed"16 by ataxpayer to the government. Examples of tax credits are withheld taxes, payments of estimated tax, and investment tax

credits.17

Tax credit should be understood in relation to other tax concepts. One of these is tax deduction -- defined as a subtraction"from income for tax purposes,"18 or an amount that is "allowed by law to reduce income prior to [the] application of the taxrate to compute the amount of tax which is due."19 An example of a tax deduction is any of the allowable deductionsenumerated in Section 3420 of the Tax Code.

A tax credit differs from a tax deduction. On the one hand, a tax credit reduces the tax due, including -- whenever applicable-- the income tax that is determined after applying the corresponding tax rates to taxable income.21 Atax deduction, on theother, reduces the income that is subject to tax22 in order to arrive at taxable income.23 To think of the former as the latter isto avoid, if not entirely confuse, the issue. A tax credit is used only after the tax has been computed; a tax deduction, before.

Tax Liability Required

for Tax Credit

Since a tax credit is used to reduce directly the tax that is due, there ought to be a tax liability before the tax credit can be

applied. Without that liability, any tax credit application will be useless. There will be no reason for deducting the latter whenthere is, to begin with, no existing obligation to the government. However, as will be presented shortly, the existence of a taxcredit or its grant by law is not the same as the availment or use of such credit. While the grant is mandatory, the availment or use is not.

If a net loss is reported by, and no other taxes are currently due from, a business establishment, there will obviously be notax liability against which any tax credit can be applied.24 For the establishment to choose the immediate availment of a tax credit will be premature and impracticable. Nevertheless, the irrefutable fact remains that, under RA 7432, Congress hasgranted without conditions a tax credit benefit to all covered establishments.

Although this tax credit benefit is available, it need not be used by losing ventures, since there is no tax liability that calls for its application. Neither can it be reduced to nil by the quick yet callow stroke of an administrative pen, simply because noreduction of taxes can instantly be effected. By its nature, the tax credit may still be deducted from a future, not a present , taxliability, without which it does not have any use. In the meantime, it need not move. But it breathes.

Prior Tax Payments Not

Required for Tax Credit

While a tax liability is essential to the availment or use of any tax credit , prior tax payments are not. On the contrary, for the existence or grant solely of such credit, neither a tax liability nor a prior tax payment is needed. The Tax Code is in factreplete with provisions granting or allowing tax credits, even though no taxes have been previously paid.

For example, in computing the estate tax due, Section 86(E) allows a tax credit -- subject to certain limitations -- for estatetaxes paid to a foreign country. Also found in Section 101(C) is a similar provision for donor’s taxes -- again when paid to aforeign country -- in computing for the donor’s tax due. The tax credits in both instances allude to the prior payment of taxes,even if not made to our government.

Under Section 110, a VAT (Value-Added Tax)- registered person engaging in transactions -- whether or not subject to the VAT-- is also allowed a tax credit that includes a ratable portion of any input tax not directly attributable to either activity. Thisinput tax may either be the VAT on the purchase or importation of goods or services that is merely due from -- not necessarilypaid by -- such VAT-registered person in the course of trade or business; or the transitional input tax determined in

accordance with Section 111(A). The latter type may in fact be an amount equivalent to only eight percent of the value of aVAT-registered person’s beginning inventory of goods, materials and supplies, when such amount -- as computed -- is higher than the actual VAT paid on the said items.25 Clearly from this provision, the tax credit refers to an input tax that is either dueonly or given a value by mere comparison with the VAT actually paid -- then later prorated. No tax is actually paid prior to theavailment of such credit.

In Section 111(B), a one and a half percent input tax credit that is merely presumptive is allowed. For the purchase of primaryagricultural products used as inputs -- either in the processing of sardines, mackerel and milk, or in the manufacture of refined sugar and cooking oil -- and for the contract price of public work contracts entered into with the government, again, noprior tax payments are needed for the use of the tax credit .

More important, a VAT-registered person whose sales are zero-rated or effectively zero-rated may, under Section 112(A),apply for the issuance of a tax credit certificate for the amount of creditable input taxes merely due -- again not necessarily



























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paid to -- the government and attributable to such sales, to the extent that the input taxes have not been applied againstoutput taxes.26 Where a taxpayer is engaged in zero-rated or effectively zero-rated sales and also in taxable or exempt sales, the amount of creditable inputtaxes due that are not directly and entirely attributable to any one of these transactions shall be proportionately allocated onthe basis of the volume of sales. Indeed, in availing of such tax credit for VAT purposes, this provision -- as well as the oneearlier mentioned -- shows that the prior payment of taxes is not a requisite.

It may be argued that Section 28(B)(5)(b) of the Tax Code is another illustration of a tax credit allowed, even though no prior tax payments are not required. Specifically, in this provision, the imposition of a final withholding tax rate on cash and/or property dividends received by a nonresident foreign corporation from a domestic corporation is subjected to the conditionthat a foreign tax credit will be given by the domiciliary country in an amount equivalent to taxes that are merely deemedpaid.27 Although true, this provision actually refers to the tax credit as a condition only for the imposition of a lower tax rate,not as a deduction from the corresponding tax liability. Besides, it is not our government but the domiciliary country thatcredits against the income tax payable to the latter by the foreign corporation, the tax to be foregone or spared.28

In contrast, Section 34(C)(3), in relation to Section 34(C)(7)(b), categorically allows as credits, against the income taximposable under Title II, the amount of income taxes merely incurred -- not necessarily paid -- by a domestic corporationduring a taxable year in any foreign country. Moreover, Section 34(C)(5) provides that for such taxes incurred but not paid,a tax credit may be allowed, subject to the condition precedent that the taxpayer shall simply give a bond with suretiessatisfactory to and approved by petitioner, in such sum as may be required; and further conditioned upon payment by thetaxpayer of any tax found due, upon petitioner’s redetermination of it.

In addition to the above-cited provisions in the Tax Code, there are also tax treaties and special laws that grant or allow tax credits, even though no prior tax payments have been made.

Under the treaties in which the tax credit method is used as a relief to avoid double taxation, income that is taxed in the stateof source is also taxable in the state of residence, but the tax paid in the former is merely allowed as a credit against the taxlevied in the latter .29 Apparently, payment is made to the state of source, not the state of residence. No tax, therefore, hasbeen previously paid to the latter.

Under special laws that particularly affect businesses, there can also be tax credit incentives. To illustrate, the incentivesprovided for in Article 48 of Presidential Decree No. (PD) 1789, as amended by Batas Pambansa Blg. (BP) 391, include tax credits equivalent to either five percent of the net value earned, or five or ten percent of the net local content of exports.30 Inorder to avail of such credits under the said law and still achieve its objectives, no prior tax payments are necessary.

From all the foregoing instances, it is evident that prior tax payments are not indispensable to the availment of a tax credit .Thus, the CA correctly held that the availment under RA 7432 did not require prior tax payments by private establishmentsconcerned.31 However, we do not agree with its finding32 that the carry-over of tax creditsunder the said special law to

succeeding taxable periods, and even their application against internal revenue taxes, did not necessitate the existence of atax liability.

The examples above show that a tax liability is certainly important in the availment or use, not the existence or grant , of a tax credit . Regarding this matter, a private establishment reporting a net loss in its financial statements is no different fromanother that presents a net income. Both are entitled to the tax credit provided for under RA 7432, since the law itself accordsthat unconditional benefit. However, for the losing establishment to immediately apply such credit, where no tax is due, will bean improvident usance.

Sections 2.i and 4 of Revenue

Regulations No. 2-94 Erroneous

RA 7432 specifically allows private establishments to claim as tax credit the amount of discounts they grant.33 In turn, theImplementing Rules and Regulations, issued pursuant thereto, provide the procedures for its availment. 34 To deny suchcredit, despite the plain mandate of the law and the regulations carrying out that mandate, is indefensible.

First , the definition given by petitioner is erroneous. It refers to tax credit as the amount representing the 20 percent discountthat "shall be deducted by the said establishments from their gross income for income tax purposes and from their grosssales for value-added tax or other percentage tax purposes."35 In ordinary business language, the tax credit represents theamount of such discount. However, the manner by which the discount shall be credited against taxes has not been clarifiedby the revenue regulations.

By ordinary acceptation, a discount is an "abatement or reduction made from the gross amount or value of anything." 36 Tobe more precise, it is in business parlance "a deduction or lowering of an amount of money;"37 or "a reduction from the fullamount or value of something, especially a price."38 In business there are many kinds of discount, the most common of which is that affecting the income statement 39 or financial report upon which theincome tax is based.

Business Discounts






























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Deducted from Gross Sales

A cash discount , for example, is one granted by business establishments to credit customers for their prompt payment.40 It isa "reduction in price offered to the purchaser if payment is made within a shorter period of time than the maximum timespecified."41 Also referred to as a sales discount on the part of the seller and a purchase discount on the part of the buyer, itmay be expressed in suchterms as "5/10, n/30."42

A quantity discount , however, is a "reduction in price allowed for purchases made in large quantities, justified by savings inpackaging, shipping, and handling."43 It is also called a volume or bulk discount .44

A "percentage reduction from the list price x x x allowed by manufacturers to wholesalers and by wholesalers toretailers"45 is known as a trade discount . No entry for it need be made in the manual or computerized books of accounts,since the purchase or sale is already valued at the net price actually charged the buyer.46 The purpose for the discount is toencourage trading or increase sales, and the prices at which the purchased goods may be resold are alsosuggested.47 Even a chain discount -- a series of discounts from one list price -- is recorded at net.48

Finally, akin to a trade discount is a functional discount . It is "a supplier’s price discount given to a purchaser based on the[latter’s] role in the [former’s] distribution system."49 This role usually involves warehousing or advertising.

Based on this discussion, we find that the nature of a sales discount is peculiar. Applying generally accepted accountingprinciples (GAAP) in the country, this type of discount is reflected in the income statement 50 as a line item deducted -- alongwith returns, allowances, rebates and other similar expenses -- from gross sales to arrive atnet sales.51 This type of

presentation is resorted to, because the accounts receivable and sales figures that arise from sales discounts, -- as well asfrom quantity, volume or bulk discounts -- are recorded in the manual and computerized books of accounts and reflected inthe financial statements at the gross amounts of the invoices.52This manner of recording credit sales -- known as the grossmethod -- is most widely used, because it is simple, more convenient to apply than the net method , and produces no materialerrors over time.53

However, under the net method used in recording trade, chain or functional discounts, only the net amounts of the invoices --after the discounts have been deducted -- are recorded in the books of accounts54 and reflected in the financial statements.

A separate line item cannot be shown,55 because the transactions themselves involving bothaccountsreceivable and sales have already been entered into, net of the said discounts.

The term sales discounts is not expressly defined in the Tax Code, but one provision adverts to amounts whose sum -- alongwith sales returns, allowances and cost of goods sold 56 -- is deducted from gross sales to come up with the grossincome, profit or margin57 derived from business.58 In another provision therein, sales discountsthat are granted andindicated in the invoices at the time of sale -- and that do not depend upon the happening of any future event -- may beexcluded from the gross sales within the same quarter they were given.59 While determinative only of the VAT, the latter provision also appears as a suitable reference point for income tax purposes already embraced in the former. After all, thesetwo provisions affirm that sales discounts are amounts that are always deductible from gross sales.

Reason for the Senior Citizen Discount:

The Law, Not Prompt Payment

A distinguishing feature of the implementing rules of RA 7432 is the private establishment’s outright deduction of the discountfrom the invoice price of the medicine sold to the senior citizen.60 It is, therefore, expected that for each retail sale madeunder this law, the discount period lasts no more than a day, because such discount is given -- and the net amount thereof collected -- immediately upon perfection of the sale.61 Although prompt payment is made for an arm’s-length transaction bythe senior citizen, the real and compelling reason for the private establishment giving the discount is that the law itself makesit mandatory.

What RA 7432 grants the senior citizen is a mere discount privilege, not a sales discount or any of the above discounts inparticular. Prompt payment is not the reason for (although a necessary consequence of) such grant. To be sure, the privilege

enjoyed by the senior citizen must be equivalent to the tax credit benefit enjoyed by the private establishment granting thediscount. Yet, under the revenue regulations promulgated by our tax authorities, this benefit has been erroneously likenedand confined to a sales discount .

To a senior citizen, the monetary effect of the privilege may be the same as that resulting from a sales discount . However, toa private establishment, the effect is different from a simple reduction in price that results from such discount. In other words,the tax credit benefit is not the same as a sales discount . To repeat from our earlier discourse, this benefit cannot and shouldnot be treated as a tax deduction.

To stress, the effect of a sales discount on the income statement and income tax return of an establishment covered by RA7432 is different from that resulting from the availment or use of its tax credit benefit. While the former is a deduction before,the latter is a deduction after , the income tax is computed. As mentioned earlier, a discount is not necessarily a salesdiscount , and a tax credit for a simple discount privilege should not be automatically treated like a sales discount . Ubi lex non













































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distinguit, nec nos distinguere debemus. Where the law does not distinguish, we ought not to distinguish.

Sections 2.i and 4 of Revenue Regulations No. (RR) 2-94 define tax credit as the 20 percent discount deductible from grossincome for income tax purposes, or from gross sales for VAT or other percentage tax purposes. In effect, the tax credit benefit under RA 7432 is related to a sales discount . This contrived definition is improper, considering that the latter has to be deducted from gross sales in order to compute the gross income in theincome statement and cannot be deductedagain, even for purposes of computing the income tax .

When the law says that the cost of the discount may be claimed as a tax credit , it means that the amount -- when claimed --shall be treated as a reduction from any tax liability, plain and simple. The option to avail of the tax credit benefit dependsupon the existence of a tax liability, but to limit the benefit to a sales discount -- which is not even identical to the discountprivilege that is granted by law -- does not define it at all and serves no useful purpose. The definition must, therefore, bestricken down.

Laws Not Amended

by Regulations

Second , the law cannot be amended by a mere regulation. In fact, a regulation that "operates to create a rule out of harmonywiththe statute is a mere nullity";62 it cannot prevail.

It is a cardinal rule that courts "will and should respect the contemporaneous construction placed upon a statute by the

executive officers whose duty it is to enforce it x x x."63 In the scheme of judicial tax administration, the need for certaintyand predictability in the implementation of tax laws is crucial. 64 Our tax authorities fill in the details that "Congress may nothave the opportunity or competence to provide."65 The regulations these authorities issue are relied upon by taxpayers, whoare certain that these will be followed by the courts.66 Courts, however, will not uphold these authorities’ interpretations whenclearly absurd, erroneous or improper.

In the present case, the tax authorities have given the term tax credit in Sections 2.i and 4 of RR 2-94 a meaning utterly incontrast to what RA 7432 provides. Their interpretation has muddled up the intent of Congress in granting a mere discountprivilege, not a sales discount . The administrative agency issuing these regulations may not enlarge, alter or restrict theprovisions of the law it administers; it cannot engraft additional requirements not contemplated by the legislature.67

In case of conflict, the law must prevail.68 A "regulation adopted pursuant to law is law."69 Conversely, a regulation or anyportion thereof not adopted pursuant to law is no law and has neither the force nor the effect of law.70

Availment of Tax

Credit Voluntary

Third , the word may in the text of the statute71 implies that theavailability of the tax credit benefit is neither unrestricted nor mandatory.72 There is no absolute right conferred uponrespondent, or any similar taxpayer, to avail itself of the tax credit remedy whenever it chooses; "neither does it impose aduty on the part of the government to sit back and allow an important facet of tax collection to be at the sole control anddiscretion of the taxpayer."73 For the tax authorities to compel respondent to deduct the 20 percent discount from either its gross income or its gross sales74 is, therefore, not only to make an imposition without basis in law, but also to blatantlycontravene the law itself.

What Section 4.a of RA 7432 means is that the tax credit benefit is merely permissive, not imperative. Respondent is giventwo options -- either to claim or not to claim the cost of the discounts as a tax credit . In fact, it may even ignore the credit andsimply consider the gesture as an act of beneficence, an expression of its social conscience.

Granting that there is a tax liability and respondent claims such cost as a tax credit , then the tax credit can easily be applied.If there is none, the credit cannot be used and will just have to be carried over and revalidated75accordingly. If, however, the

business continues to operate at a loss and no other taxes are due, thus compelling it to close shop, the credit can never beapplied and will be lost altogether.

In other words, it is the existence or the lack of a tax liability that determines whether the cost of the discounts can be usedas a tax credit . RA 7432 does not give respondent the unfettered right to avail itself of the credit whenever it pleases. Neither does it allow our tax administrators to expand or contract the legislative mandate. "The ‘plain meaning rule’ or verba legis instatutory construction is thus applicable x x x. Where the words of a statute are clear, plain and free from ambiguity, it mustbe given its literal meaning and applied without attempted interpretation."76

Tax Credit Benefit

Deemed Just Compensation

Fourth, Sections 2.i and 4 of RR 2-94 deny the exercise by the State of its power of eminent domain. Be it stressed that the































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privilege enjoyed by senior citizens does not come directly from the State, but rather from the private establishmentsconcerned. Accordingly, the tax credit benefit granted to these establishments can be deemed as their just compensation for private property taken by the State for public use.77

The concept of public use is no longer confined to the traditional notion of use by the public , but held synonymous with public interest , public benefit , public welfare, and public convenience.78 The discount privilege to which our senior citizens areentitled is actually a benefit enjoyed by the general public to which these citizens belong. The discounts given would haveentered the coffers and formed part of the gross sales of the private establishments concerned, were it not for RA 7432. Thepermanent reduction in their total revenues is a forced subsidy corresponding to the taking of private property for public useor benefit .

As a result of the 20 percent discount imposed by RA 7432, respondent becomes entitled to a just compensation. This termrefers not only to the issuance of a tax credit certificate indicating the correct amount of the discounts given, but also to thepromptness in its release. Equivalent to the payment of property taken by the State, such issuance -- when not done withina reasonable time from the grant of the discounts -- cannot be considered as just compensation. In effect, respondent ismade to suffer the consequences of being immediately deprived of its revenues while awaiting actual receipt, through thecertificate, of the equivalent amount it needs to cope with the reduction in its revenues.79

Besides, the taxation power can also be used as an implement for the exercise of the power of eminent domain. 80Taxmeasures are but "enforced contributions exacted on pain of penal sanctions"81 and "clearly imposed for a public

purpose."82 In recent years, the power to tax has indeed become a most effective tool to realize social justice, public welfare,and the equitable distribution of wealth.83

While it is a declared commitment under Section 1 of RA 7432, social justice "cannot be invoked to trample on the rights of property owners who under our Constitution and laws are also entitled to protection. The social justice consecrated in our [C]onstitution [is] not intended to take away rights from a person and give them to another who is not entitled thereto." 84 For this reason, a just compensation for income that is taken away from respondent becomes necessary. It is in the tax credit thatour legislators find support to realize social justice, and no administrative body can alter that fact.

To put it differently, a private establishment that merely breaks even85 -- without the discounts yet -- will surely start to incur losses because of such discounts. The same effect is expected if its mark-up is less than 20 percent, and if all its sales comefrom retail purchases by senior citizens. Aside from the observation we have already raised earlier, it will also be grosslyunfair to an establishment if the discounts will be treated merely as deductions from either its gross income or its gross sales.Operating at a loss through no fault of its own, it will realize that the tax credit limitation under RR 2-94 is inutile, if notimproper. Worse, profit-generating businesses will be put in a better position if they avail themselves of tax credits deniedthose that are losing, because no taxes are due from the latter.

Grant of Tax Credit

Intended by the Legislature

Fifth, RA 7432 itself seeks to adopt measures whereby senior citizens are assisted by the community as a whole and toestablish a program beneficial to them.86 These objectives are consonant with the constitutional policy of making "health x xx services available to all the people at affordable cost"87 and of giving "priority for the needs of the x x x elderly."88 Sections2.i and 4 of RR 2-94, however, contradict these constitutional policies and statutory objectives.

Furthermore, Congress has allowed all private establishments a simple tax credit , not a deduction. In fact, no cash outlay isrequired from the government for the availment or use of such credit. The deliberations on February 5, 1992 of the BicameralConference Committee Meeting on Social Justice, which finalized RA 7432, disclose the true intent of our legislators to treatthe sales discounts as a tax credit , rather than as a deduction from gross income. We quote from those deliberations asfollows:

"THE CHAIRMAN (Rep. Unico). By the way, before that ano, about deductions from taxable income. I think we incorporatedthere a provision na - on the responsibility of the private hospitals and drugstores, hindi ba?

SEN. ANGARA. Oo.

THE CHAIRMAN. (Rep. Unico), So, I think we have to put in also a provision here about the deductions from taxable incomeof that private hospitals, di ba ganon 'yan?

MS. ADVENTO. Kaya lang po sir, and mga discounts po nila affecting government and public institutions, so, puwede na ponating hindi isama yung mga less deductions ng taxable income.

THE CHAIRMAN. (Rep. Unico). Puwede na. Yung about the private hospitals. Yung isiningit natin?

MS. ADVENTO. Singit na po ba yung 15% on credit. (inaudible/did not use the microphone).

SEN. ANGARA. Hindi pa, hindi pa.

THE CHAIRMAN. (Rep. Unico) Ah, 'di pa ba naisama natin?

























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SEN. ANGARA. Oo. You want to insert that?

THE CHAIRMAN (Rep. Unico). Yung ang proposal ni Senator Shahani, e.

SEN. ANGARA. In the case of private hospitals they got the grant of 15% discount, provided that, the private hospitals canclaim the expense as a tax credit.

REP. AQUINO. Yah could be allowed as deductions in the perpetrations of (inaudible) income.SEN. ANGARA. I-tax credit na lang natin para walang cash-out ano?

REP. AQUINO. Oo, tax credit. Tama, Okay. Hospitals ba o lahat ng establishments na covered.

THE CHAIRMAN. (Rep. Unico). Sa kuwan lang yon, as private hospitals lang.

REP. AQUINO. Ano ba yung establishments na covered?

SEN. ANGARA. Restaurant lodging houses, recreation centers.

REP. AQUINO. All establishments covered siguro?

SEN. ANGARA. From all establishments. Alisin na natin 'Yung kuwan kung ganon. Can we go back to Section 4 ha?

REP. AQUINO. Oho.

SEN. ANGARA. Letter A. To capture that thought, we'll say the grant of 20% discount from all establishments et cetera, et

cetera, provided that said establishments - provided that private establishments may claim the cost as a tax credit. Ganon ba'yon?

REP. AQUINO. Yah.

SEN. ANGARA. Dahil kung government, they don't need to claim it.

THE CHAIRMAN. (Rep. Unico). Tax credit.

SEN. ANGARA. As a tax credit [rather] than a kuwan - deduction, Okay.

REP. AQUINO Okay.

SEN. ANGARA. Sige Okay. Di subject to style na lang sa Letter A".89

Special Law

Over General Law

Sixth and last , RA 7432 is a special law that should prevail over the Tax Code -- a general law. "x x x [T]he rule is that on aspecific matter the special law shall prevail over the general law, which shallbe resorted to only to supply deficiencies in the former."90 In addition, "[w]here there are two statutes, the earlier special andthe later general -- the terms of the general broad enough to include the matter provided for in the special -- the fact that oneis special and the other is general creates a presumption that the special is to be considered as remaining an exception tothe general,91 one as a general law of the land, the other as the law of a particular case."92 "It is a canon of statutoryconstruction that a later statute, general in its terms and not expressly repealing a prior special statute, will ordinarily notaffect the special provisions of such earlier statute."93

RA 7432 is an earlier law not expressly repealed by, and therefore remains an exception to, the Tax Code -- a later law.When the former states that a tax credit may be claimed, then the requirement of prior tax payments under certain provisionsof the latter, as discussed above, cannot be made to apply. Neither can the instances of or references to a tax deduction under the Tax Code94 be made to restrict RA 7432. No provision of any revenue regulation can supplant or modifythe acts of Congress.

WHEREFORE, the Petition is hereby DENIED. The assailed Decision and Resolution of the Court of Appeals AFFIRMED. Nopronouncement as to costs.

SO ORDERED

G.R. No. L-26911 January 27, 1981 ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION, petitioner,vs. COMMISSIONER OF INTERNAL REVENUE, respondent.

G.R. No. L-26924 January 27, 1981 COMMISSIONER OF INTERNAL REVENUE, petitioner,vs. ATLAS CONSOLIDATED MINING & DEVELOPMENT CORPORATION and COURT OF TAX APPEALS, respondents.

DE CASTRO, J.:

These are two (2) petitions for review from the decision of the Court of Tax Appeals of October 25, 1966 in CTA Case No.













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1312 entitled "Atlas Consolidated Mining and Development Corporation vs. Commissioner of Internal Revenue." One (L-26911) was filed by the Atlas Consolidated Mining & Development Corporation, and in the other L-26924), the Commissioner of Internal Revenue is the petitioner.

This tax case (CTA No. 1312) arose from the 1957 and 1958 deficiency income tax assessments made by the Commissioner of Internal Revenue, hereinafter referred to as Commissioner, where the Atlas Consolidated Mining and DevelopmentCorporation, hereinafter referred to as Atlas, was assessed P546,295.16 for 1957 and P215,493.96 for 1958 deficiencyincome taxes.

Atlas is a corporation engaged in the mining industry registered under the laws of the Philippines. On August 20, 1962, theCommissioner assessed against Atlas the sum of P546,295.16 and P215,493.96 or a total of P761,789.12 as deficiencyincome taxes for the years 1957 and 1958. For the year 1957, it was the opinion of the Commissioner that Atlas is notentitled to exemption from the income tax under Section 4 of Republic Act 909 1because same covers only gold mines, theprovision of which reads:

New mines, and old mines which resume operation, when certified to as such by the Secretary of Agriculture and Natural Resources upon the recommendation of the Director of Mines, shall be exemptfrom the payment of income tax during the first three (3) years of actual commercial production. Providedthat, any such mine and/or mines making a complete return of its capital investment at any time within thesaid period, shall pay income tax from that year.

For the year 1958, the assessment of deficiency income tax of P761,789.12 covers the disallowance of items claimed by Atlas as deductible from gross income.

On October 9, 1962, Atlas protested the assessment asking for its reconsideration and cancellation. 2 Acting on the protest,the Commissioner conducted a reinvestigation of the case.

On October 25, 1962, the Secretary of Finance ruled that the exemption provided in Republic Act 909 embraces all newmines and old mines whether gold or other minerals. 3 Accordingly, the Commissioner recomputed Atlas deficiency incometax liabilities in the light of the ruling of the Secretary of Finance. On June 9, 1964, the Commissioner issued a revisedassessment entirely eliminating the assessment of P546,295.16 for the year 1957. The assessment for 1958 was reducedfrom P215,493.96 to P39,646.82 from which Atlas appealed to the Court of Tax Appeals, assailing the disallowance of thefollowing items claimed as deductible from its gross income for 1958:

Transfer agent's fee.........................................................P59,477.42

Stockholders relation service fee....................................25,523.14

U.S. stock listing expenses..................................................8,326.70

Suit expenses..........................................................................6,666.65

Provision for contingencies..................................... .........60,000.00

Total....................................................................P159,993.91

After hearing, the Court of Tax Appeals rendered a decision on October 25, 1966 allowing the above mentioned disalloweditems, except the items denominated by Atlas as stockholders relation service fee and suit expenses. 4Pertinent portions of the decision of the Court of Tax Appeals read as follows:

Under the facts, circumstances and applicable law in this case, the unallowable deduction from petitioner'sgross income in 1958 amounted to P32,189.79.

Stockholders relation service fee.................................... P25,523.14

Suit and litigation expenses................................................ 6,666.65

Total................................................................................... P32,189.79

As the exemption of petitioner from the payment of corporate income tax under Section 4, Republic Act909, was good only up to the Ist quarter of 1958 ending on March 31 of the same year, only three-fourth(3/4) of the net taxable income of petitioner is subject to income tax, computed as follows:

1958

Total net income for 1958.................................P1,968,898.27

Net income corresponding to

taxable period April 1 to

Dec. 31, 1958, 3/4 of

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P1,968,898.27..........................................................1,476,673.70

Add: 3/4 of promotion fees

of P25,523.14..............................................................P19,142.35

Litigation

expenses.........................................................................6, 666.65

Net income per decision..........................................11, 02,4 2.70

Tax due thereon.........................................................412,695.00

Less: Amount already assessed .............................405,468.00

DEFICIENCY INCOME TAX DUE............................P7,227.00

Add: 1/2 % monthly interest

from 6-20-59 to 6-20-62 (18%)....................................P1,300.89

TOTAL AMOUNT DUE & COLLECTIBLE............P8,526.22

From the Court of Tax Appeals' decision of October 25, 1966, both parties appealed to this Court by way of two (2) separatepetitions for review docketed as G. R. No. L-26911 (Atlas, petitioner) and G. R. No. L-29924 (Commissioner, petitioner).

G. R. No. L-26911—Atlas appealed only that portion of the Court of Tax Appeals' decision disallowing the deduction fromgross income of the so-called stockholders relation service fee amounting to P25,523.14, making a lone assignment of error that —

THE COURT OF TAX APPEALS ERRED IN ITS CONCLUSION THAT THE EXPENSE IN THE AMOUNTOF P25,523.14 PAID BY PETITIONER IN 1958 AS ANNUAL PUBLIC RELATIONS EXPENSES WASINCURRED FOR ACQUISITION OF ADDITIONAL CAPITAL, THE SAME NOT BEING SUPPORTED BYTHE EVIDENCE.

It is the contention of Atlas that the amount of P25,523.14 paid in 1958 as annual public relations expenses is a deductibleexpense from gross income under Section 30 (a) (1) of the National Internal Revenue Code. Atlas claimed that it was paid for services of a public relations firm, P.K Macker & Co., a reputable public relations consultant in New York City, U.S.A., hence,an ordinary and necessary business expense in order to compete with other corporations also interested in the investmentmarket in the United States. 5 It is the stand of Atlas that information given out to the public in general and to the stockholder in particular by the P.K MacKer & Co. concerning the operation of the Atlas was aimed at creating a favorable image and

goodwill to gain or maintain their patronage.

The decisive question, therefore, in this particular appeal taken by Atlas to this Court is whether or not the expenses paid for the services rendered by a public relations firm P.K MacKer & Co. labelled as stockholders relation service fee is anallowable deduction as business expense under Section 30 (a) (1) of the National Internal Revenue Code.

The principle is recognized that when a taxpayer claims a deduction, he must point to some specific provision of the statutein which that deduction is authorized and must be able to prove that he is entitled to the deduction which the law allows. Aspreviously adverted to, the law allowing expenses as deduction from gross income for purposes of the income tax is Section30 (a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." An item of expenditure, in order to be deductible under this section of the statute, must fall squarely within its language.

We come, then, to the statutory test of deductibility where it is axiomatic that to be deductible as a business expense, threeconditions are imposed, namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred within thetaxable year, and (3) it must be paid or incurred in carrying in a trade or business. 6 In addition, not only must the taxpayer

meet the business test, he must substantially prove by evidence or records the deductions claimed under the law, otherwise,the same will be disallowed. The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not

justify its deduction. 7

While it is true that there is a number of decisions in the United States delving on the interpretation of the terms "ordinary andnecessary" as used in the federal tax laws, no adequate or satisfactory definition of those terms is possible. Similarly, thisCourt has never attempted to define with precision the terms "ordinary and necessary." There are however, certain guidingprinciples worthy of serious consideration in the proper adjudication of conflicting claims. Ordinarily, an expense will beconsidered "necessary" where the expenditure is appropriate and helpful in the development of the taxpayer's business. 8 Itis "ordinary" when it connotes a payment which is normal in relation to the business of the taxpayer and the surroundingcircumstances. 9 The term "ordinary" does not require that the payments be habitual or normal in the sense that the sametaxpayer will have to make them often; the payment may be unique or non-recurring to the particular taxpayer affected. 10

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There is thus no hard and fast rule on the matter. The right to a deduction depends in each case on the particular facts andthe relation of the payment to the type of business in which the taxpayer is engaged. The intention of the taxpayer often maybe the controlling fact in making the determination. 11 Assuming that the expenditure is ordinary and necessary in theoperation of the taxpayer's business, the answer to the question as to whether the expenditure is an allowable deduction as abusiness expense must be determined from the nature of the expenditure itself, which in turn depends on the extent andpermanency of the work accomplished by the expenditure. 12

It appears that on December 27, 1957, Atlas increased its capital stock from P15,000,000 to P18,325,000. 13 It was claimedby Atlas that its shares of stock worth P3,325,000 were sold in the United States because of the services rendered by thepublic relations firm, P. K. Macker & Company. The Court of Tax Appeals ruled that the information about Atlas given out andplayed up in the mass communication media resulted in full subscription of the additional shares issued by Atlas;consequently, the questioned item, stockholders relation service fee, was in effect spent for the acquisition of additionalcapital, ergo, a capital expenditure.

We sustain the ruling of the tax court that the expenditure of P25,523.14 paid to P.K. Macker & Co. as compensation for services carrying on the selling campaign in an effort to sell Atlas' additional capital stock of P3,325,000 is not an ordinaryexpense in line with the decision of U.S. Board of Tax Appeals in the case of Harrisburg Hospital Inc. vs. Commissioner of Internal Revenue. 14 Accordingly, as found by the Court of Tax Appeals, the said expense is not deductible from Atlas grossincome in 1958 because expenses relating to recapitalization and reorganization of the corporation (Missouri-Kansas PipeLine vs. Commissioner of Internal Revenue, 148 F. (2d), 460; Skenandos Rayon Corp. vs. Commissioner of Internal Revenue, 122 F. (2d) 268, Cert. denied 314 U.S. 6961), the cost of obtaining stock subscription ( Simons Co., 8 BTA 631),promotion expenses (Beneficial Industrial Loan Corp. vs. Handy , 92 F. (2d) 74), and commission or fees paid for the sale of stock reorganization (Protective Finance Corp., 23 BTA 308) are capital expenditures.

That the expense in question was incurred to create a favorable image of the corporation in order to gain or maintain thepublic's and its stockholders' patronage, does not make it deductible as business expense. As held in the case of Welch vs.Helvering, 15 efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related theretoare not business expense but capital expenditures.

We do not agree with the contention of Atlas that the conclusion of the Court of Tax Appeals in holding that the expense of P25,523.14 was incurred for acquisition of additional capital is not supported by the evidence. The burden of proof that theexpenses incurred are ordinary and necessary is on the taxpayer 16 and does not rest upon the Government. To avail of theclaimed deduction under Section 30(a) (1) of the National Internal Revenue Code, it is incumbent upon the taxpayer toadduce substantial evidence to establish a reasonably proximate relation petition between the expenses to the ordinaryconduct of the business of the taxpayer. A logical link or nexus between the expense and the taxpayer's business must beestablished by the taxpayer.

G. R. No. L-26924-In his petition for review, the Commissioner of Internal Revenue assigned as errors the following:

I

THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OFTHE SO- CALLED TRANSFER AGENT'S FEES ALLEGEDLY PAID BY RESPONDENT;

II

THE COURT OF TAX APPEALS ERRED IN ALLOWING THE DEDUCTION FROM GROSS INCOME OFLISTING EXPENSES ALLEGEDLY INCURRED BY RESPONDENT;

III

THE COURT OF TAX APPEALS ERRED IN HOLDING THAT THE AMOUNT OF P60,000 REPRESENTEDBY RESPONDENT AS "PROVISION FOR CONTINGENCIES" WAS ADDED BACK BY RESPONDENT TOITS GROSS INCOME IN COMPUTING THE INCOME TAX DUE FROM IT FOR 1958;

IVTHE COURT OF TAX APPEALS ERRED IN DISALLOWING ONLY THE AMOUNT OF P6,666.65 AS SUITEXPENSES, THE CORRECT AMOUNT THAT SHOULD HAVE BEEN DISALLOWED BEING P17,499.98.

It is well to note that only in the Court of Tax Appeals did the Commissioner raise for the first time (in his memorandum) thequestion of whether or not the business expenses deducted from Atlas gross income in 1958 may be allowed in the absenceof proof of payments. 17 Before this Court, the Commissioner reiterated the same as ground against deductibility when heclaimed that the Court of Tax Appeals erred in allowing the deduction of transfer agent's fee and stock listing fee from grossincome in the absence of proof of payment thereof.

The Commissioner contended that under Section 30 (a) (1) of the National Internal Revenue Code, it is a requirement for anexpense to be deductible from gross income that it must have been "paid or incurred during the year" for which it is claimed;that in the absence of convincing and satisfactory evidence of payment, the deduction from gross income for the year 1958

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income tax return cannot be sustained; and that the best evidence to prove payment, if at all any has been made, would bethe vouchers or receipts issued therefor which ATLAS failed to present.

Atlas admitted that it failed to adduce evidence of payment of the deduction claimed in its 1958 income tax return, butexplains the failure with the allegation that the Commissioner did not raise that question of fact in his pleadings, or even inthe report of the investigating examiner and/or letters of demand and assessment notices of ATLAS which gave rise to itsappeal to the Court of Tax Appeal. 18 It was emphasized by Atlas that it went to trial and finally submitted this case for decision on the assumption that inasmuch as the fact of payment was never raised as a vital issue by the Commissioner inhis answer to the petition for review in the Court of Tax Appeal, the issues is limited only to pure question of law—whether or not the expenses deducted by petitioner from its gross income for 1958 are sanctioned by Section 30 (a) (1) of the NationalInternal Revenue Code.

On this issue of whether or not the Commissioner can raise the fact of payment for the first time on appeal in itsmemorandum in the Court of Tax Appeal, we fully agree with the ruling of the tax court that the Commissioner on appealcannot be allowed to adopt a theory distinct and different from that he has previously pursued, as shown by the BIR recordsand the answer to the amended petition for review. 19 As this Court said in the case of Commissioner of Customs vs.Valencia 20 such change in the nature of the case may not be made on appeal, specially when the purpose of the latter is toseek a review of the action taken by an administrative body, forming part of a coordinate branch of the Government, such asthe Executive department. In the case at bar, the Court of Tax Appeal found that the fact of payment of the claimed deductionfrom gross income was never controverted by the Commissioner even during the initial stages of routinary administrativescrutiny conducted by BIR examiners.21 Specifically, in his answer to the amended petition for review in the Court of Tax

Appeal, the Commissioner did not deny the fact of payment, merely contesting the legitimacy of the deduction on the groundthat same was not ordinary and necessary business expenses. 22

As consistently ruled by this Court, the findings of facts by the Court of Tax Appeal will not be reviewed in the absence of showing of gross error or abuse. 23 We, therefore, hold that it was too late for the Commissioner to raise the issue of fact of payment for the first time in his memorandum in the Court of Tax Appeals and in this instant appeal to the Supreme Court. If raised earlier, the matter ought to have been seriously delved into by the Court of Tax Appeals. On this ground, we are of theopinion that under all the attendant circumstances of the case, substantial justice would be served if the Commissioner beheld as precluded from now attempting to raise an issue to disallow deduction of the item in question at this stage. Failure toassert a question within a reasonable time warrants a presumption that the party entitled to assert it either has abandoned or declined to assert it.

On the second assignment of error, aside from alleging lack of proof of payment of the expense deducted, the Commissioner contended that such expense should be disallowed for not being ordinary and necessary and not incurred in trade or business, as required under Section 30 (a) (1) of the National Internal Revenue Code. He asserted that said fees weretherefore incurred not for the production of income but for the acquisition petition of capital in view of the definition that an

expense is deemed to be incurred in trade or business if it was incurred for the production of income, or in the expectation of producing income for the business. In support of his contention, the Commissioner cited the ruling in Dome Mines, Ltd vs.Commisioner of Internal Revenue 24 involving the same issue as in the case at bar where the U.S. Board of Tax Appeal ruledthat expenses for listing capital stock in the stock exchange are not ordinary and necessary expenses incurred in carrying onthe taxpayer's business which was gold mining and selling, which business is strikingly similar to Atlas.

On the other hand, the Court of Tax Appeal relied on the ruling in the case of Chesapeake Corporation of Virginia vs.Commissioner of Internal Revenue 25 where the Tax Court allowed the deduction of stock exchange fee in dispute, which isan annually recurring cost for the annual maintenance of the listing.

We find the Chesapeake decision controlling with the facts and circumstances of the instant case. In Dome Mines, Ltd case the stock listing fee was disallowed as a deduction not only because the expenditure did not meet the statutory test butalso because the same was paid only once, and the benefit acquired thereby continued indefinitely, whereas, inthe Chesapeake Corporation case, fee paid to the stock exchange was annual and recurring. In the instant case, we dealwith the stock listing fee paid annually to a stock exchange for the privilege of having its stock listed. It must be noted that theCourt of Tax Appeal rejected the Dome Mines case because it involves a payment made only once, hence, it was held

therein that the single payment made to the stock exchange was a capital expenditure, as distinguished from the instantcase, where payments were made annually. For this reason, we hold that said listing fee is an ordinary and necessarybusiness expense

On the third assignment of error, the Commissioner contended that the Court of Tax Appeal erred when it held that theamount of P60,000 as "provisions for contingencies" was in effect added back to Atlas income.

On this issue, this Court has consistently ruled in several cases adverted to earlier, that in the absence of grave abuse of discretion or error on the part of the tax court its findings of facts may not be disturbed by the Supreme Court. 26 It is notwithin the province of this Court to resolve whether or not the P60,000 representing "provision for contingencies" was in factadded to or deducted from the taxable income. As ruled by the Court of Tax Appeals, the said amount was in effect added to

Atlas taxable income. 27 The same being factual in nature and supported by substantial evidence, such findings should notbe disturbed in this appeal.

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Finally, in its fourth assignment of error, the Commissioner contended that the CTA erred in disallowing only the amount of P6,666.65 as suit expenses instead of P17,499.98.

It appears that petitioner deducted from its 1958 gross income the amount of P23,333.30 as attorney's fees and litigationexpenses in the defense of title to the Toledo Mining properties purchased by Atlas from Mindanao Lode Mines Inc. in CivilCase No. 30566 of the Court of First Instance of Manila for annulment of the sale of said mining properties. On the groundthat the litigation expense was a capital expenditure under Section 121 of the Revenue Regulation No. 2, the investigatingrevenue examiner recommended the disallowance of P13,333.30. The Commissioner, however, reduced this amount of P6,666.65 which latter amount was affirmed by the respondent Court of Tax Appeals on appeal.

There is no question that, as held by the Court of Tax Ap- peals, the litigation expenses under consideration were incurred indefense of Atlas title to its mining properties. In line with the decision of the U.S. Tax Court in the case of Safety Tube Corp.vs. Commissioner of Internal Revenue, 28 it is well settled that litigation expenses incurred in defense or protection of title arecapital in nature and not deductible. Likewise, it was ruled by the U.S. Tax Court that expenditures in defense of title of property constitute a part of the cost of the property, and are not deductible as expense. 29

Surprisingly, however, the investigating revenue examiner recommended a partial disallowance of P13,333.30 instead of theentire amount of P23,333.30, which, upon review, was further reduced by the Commissioner of Internal Revenue. Whether itwas due to mistake, negligence or omission of the officials concerned, the arithmetical error committed herein should notprejudice the Government. This Court will pass upon this particular question since there is a clear error committed by officialsconcerned in the computation of the deductible amount. As held in the case of Vera vs. Fernandez, 30 this Courtemphatically said that taxes are the lifeblood of the Government and their prompt and certain availability are imperious need.

Upon taxation depends the Government's ability to serve the people for whose benefit taxes are collected. To safeguard suchinterest, neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harmor detriment to the people, in the same manner as private persons may be made to suffer individually on account of his ownnegligence, the presumption being that they take good care of their personal affair. This should not hold true to governmentofficials with respect to matters not of their own personal concern. This is the philosophy behind the government's exception,as a general rule, from the operation of the principle of estoppel. 31

WHEREFORE, judgment appealed from is hereby affirmed with modification that the amount of P17,499.98 (3/4 of P23,333.00) representing suit expenses be disallowed as deduction instead of P6,666.65 only. With this amount as part of the net income, the corresponding income tax shall be paid thereon, with interest of 6% per annum from June 20, 1959 toJune 20,1962.

SO ORDERED.

Makasiar, Fernandez, Guerrero and Melencio-Herrera, ,JJ., concur.

Teehankee, J., (Chairman), took no part.

G.R. No. 143672 April 24, 2003 COMMISSIONER OF INTERNAL REVENUE, petitioner,vs. GENERAL FOODS (PHILS.), INC., respondent. CORONA, J .:

Petitioner Commissioner of Internal Revenue (Commissioner) assails the resolution1 of the Court of Appeals reversing thedecision2 of the Court of Tax Appeals which in turn denied the protest filed by respondent General Foods (Phils.), Inc.,regarding the assessment made against the latter for deficiency taxes.

The records reveal that, on June 14, 1985, respondent corporation, which is engaged in the manufacture of beverages suchas "Tang," "Calumet" and "Kool-Aid," filed its income tax return for the fiscal year ending February 28, 1985. In said taxreturn, respondent corporation claimed as deduction, among other business expenses, the amount of P9,461,246 for mediaadvertising for "Tang."

On May 31, 1988, the Commissioner disallowed 50% or P4,730,623 of the deduction claimed by respondent corporation.Consequently, respondent corporation was assessed deficiency income taxes in the amount of P2,635, 141.42. The latter filed a motion for reconsideration but the same was denied.

On September 29, 1989, respondent corporation appealed to the Court of Tax Appeals but the appeal was dismissed:

With such a gargantuan expense for the advertisement of a singular product, which even excludes "other advertisingand promotions" expenses, we are not prepared to accept that such amount is reasonable "to stimulate the currentsale of merchandise" regardless of Petitioner’s explanation that such expense "does not connote unreasonablenessconsidering the grave economic situation taking place after the Aquino assassination characterized by capital fight,strong deterioration of the purchasing power of the Philippine peso and the slacking demand for consumer products"(Petitioner’s Memorandum, CTA Records, p. 273). We are not convinced with such an explanation. The staggeringexpense led us to believe that such expenditure was incurred "to create or maintain some form of good will for thetaxpayer’s trade or business or for the industry or profession of which the taxpayer is a member." The term "goodwill" can hardly be said to have any precise signification; it is generally used to denote the benefit arising fromconnection and reputation (Words and Phrases, Vol. 18, p. 556 citing Douhart vs. Loagan, 86 III. App. 294). As held

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in the case of Welch vs. Helvering , efforts to establish reputation are akin to acquisition of capital assets and,therefore, expenses related thereto are not business expenses but capital expenditures. ( Atlas Mining and Development Corp. vs. Commissioner of Internal Revenue, supra). For sure such expenditure was meant not only togenerate present sales but more for future and prospective benefits. Hence, "abnormally large expenditures for advertising are usually to be spread over the period of years during which the benefits of the expenditures arereceived" (Mertens, supra, citing Colonial Ice Cream Co., 7 BTA 154).

WHEREFORE, in all the foregoing, and finding no error in the case appealed from, we hereby RESOLVE toDISMISS the instant petition for lack of merit and ORDER the Petitioner to pay the respondent Commissioner theassessed amount of P2,635,141.42 representing its deficiency income tax liability for the fiscal year ended February28, 1985."3

Aggrieved, respondent corporation filed a petition for review at the Court of Appeals which rendered a decision reversing andsetting aside the decision of the Court of Tax Appeals:

Since it has not been sufficiently established that the item it claimed as a deduction is excessive, the same shouldbe allowed.

WHEREFORE, the petition of petitioner General Foods (Philippines), Inc. is hereby GRANTED. Accordingly, theDecision, dated 8 February 1994 of respondent Court of Tax Appeals is REVERSED and SET ASIDE and the letter,dated 31 May 1988 of respondent Commissioner of Internal Revenue is CANCELLED.

SO ORDERED.4

Thus, the instant petition, wherein the Commissioner presents for the Court’s consideration a lone issue: whether or not thesubject media advertising expense for "Tang" incurred by respondent corporation was an ordinary and necessary expensefully deductible under the National Internal Revenue Code (NIRC).

It is a governing principle in taxation that tax exemptions must be construed in strictissimi juris against the taxpayer andliberally in favor of the taxing authority;5 and he who claims an exemption must be able to justify his claim by the clearestgrant of organic or statute law. An exemption from the common burden cannot be permitted to exist upon vagueimplications.6

Deductions for income tax purposes partake of the nature of tax exemptions; hence, if tax exemptions are strictly construed,then deductions must also be strictly construed.

We then proceed to resolve the singular issue in the case at bar. Was the media advertising expense for "Tang" paid or incurred by respondent corporation for the fiscal year ending February 28, 1985 "necessary and ordinary," hence, fullydeductible under the NIRC? Or was it a capital expenditure, paid in order to create "goodwill and reputation" for respondent

corporation and/or its products, which should have been amortized over a reasonable period?Section 34 (A) (1), formerly Section 29 (a) (1) (A), of the NIRC provides:

(A) Expenses.-

(1) Ordinary and necessary trade, business or professional expenses.-

(a) In general .- There shall be allowed as deduction from gross income all ordinary and necessaryexpenses paid or incurred during the taxable year in carrying on, or which are directly attributable to, thedevelopment, management, operation and/or conduct of the trade, business or exercise of a profession.

Simply put, to be deductible from gross income, the subject advertising expense must comply with the following requisites:(a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it musthave been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts,records or other pertinent papers.7

The parties are in agreement that the subject advertising expense was paid or incurred within the corresponding taxable year and was incurred in carrying on a trade or business. Hence, it was necessary. However, their views conflict as to whether or not it was ordinary. To be deductible, an advertising expense should not only be necessary but also ordinary. These tworequirements must be met.

The Commissioner maintains that the subject advertising expense was not ordinary on the ground that it failed the twoconditions set by U.S. jurisprudence: first, "reasonableness" of the amount incurred and second, the amount incurred mustnot be a capital outlay to create "goodwill" for the product and/or private respondent’s business. Otherwise, the expense mustbe considered a capital expenditure to be spread out over a reasonable time.

We agree.

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There beingno hard and fast rule on the matter, the right to a deduction depends on a number of factors such as but not limited to: the

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type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of theexpenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation.

In the case at bar, the P9,461,246 claimed as media advertising expense for "Tang" alone was almost one-half of its totalclaim for "marketing expenses." Aside from that, respondent-corporation also claimed P2,678,328 as "other advertising andpromotions expense" and another P1,548,614, for consumer promotion.

Furthermore, the subject P9,461,246 media advertising expense for "Tang" was almost double the amount of respondentcorporation’s P4,640,636 general and administrative expenses.

We find the subject expense for the advertisement of a single product to be inordinately large. Therefore, even if it isnecessary, it cannot be considered an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC.

Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2)advertising designed to stimulate the future sale of merchandise or use of services. The second type involves expendituresincurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer’s trade or business or for theindustry or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then,except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as businessexpenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time.

We agree with the Court of Tax Appeals that the subject advertising expense was of the second kind. Not only was the

amount staggering; the respondent corporation itself also admitted, in its letter protest8 to the Commissioner of InternalRevenue’s assessment, that the subject media expense was incurred in order to protect respondent corporation’s brandfranchise, a critical point during the period under review.

The protection of brand franchise is analogous to the maintenance of goodwill or title to one’s property. This is a capitalexpenditure which should be spread out over a reasonable period of time.9

Respondent corporation’s venture to protect its brand franchise was tantamount to efforts to establish a reputation. This wasakin to the acquisition of capital assets and therefore expenses related thereto were not to be considered as businessexpenses but as capital expenditures.10

True, it is the taxpayer’s prerogative to determine the amount of advertising expenses it will incur and where to applythem.11 Said prerogative, however, is subject to certain considerations. The first relates to the extent to which theexpenditures are actually capital outlays; this necessitates an inquiry into the nature or purpose of such expenditures.12 Thesecond, which must be applied in harmony with the first, relates to whether the expenditures are ordinary and necessary.Concomitantly, for an expense to be considered ordinary, it must be reasonable in amount. The Court of Tax Appeals ruled

that respondent corporation failed to meet the two foregoing limitations.

We find said ruling to be well founded. Respondent corporation incurred the subject advertising expense in order to protectits brand franchise. We consider this as a capital outlay since it created goodwill for its business and/or product. TheP9,461,246 media advertising expense for the promotion of a single product, almost one-half of petitioner corporation’s entireclaim for marketing expenses for that year under review, inclusive of other advertising and promotion expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly unreasonable.

It has been a long standing policy and practice of the Court to respect the conclusions of quasi-judicial agencies such as theCourt of Tax Appeals, a highly specialized body specifically created for the purpose of reviewing tax cases. The CTA, by thenature of its functions, is dedicated exclusively to the study and consideration of tax problems. It has necessarily developedan expertise on the subject. We extend due consideration to its opinion unless there is an abuse or improvident exercise of authority.13 Since there is none in the case at bar, the Court adheres to the findings of the CTA.

Accordingly, we find that the Court of Appeals committed reversible error when it declared the subject media advertisingexpense to be deductible as an ordinary and necessary expense on the ground that "it has not been established that the item

being claimed as deduction is excessive." It is not incumbent upon the taxing authority to prove that the amount of itemsbeing claimed is unreasonable. The burden of proof to establish the validity of claimed deductions is on the taxpayer.14 Inthe present case, that burden was not discharged satisfactorily.

WHEREFORE, premises considered, the instant petition is GRANTED. The assailed decision of the Court of Appeals ishereby REVERSED and SET ASIDE. Pursuant to Sections 248 and 249 of the Tax Code, respondent General Foods (Phils.),Inc. is hereby ordered to pay its deficiency income tax in the amount of P2,635,141.42, plus 25% surcharge for late paymentand 20% annual interest computed from August 25, 1989, the date of the denial of its protest, until the same is fully paid.

SO ORDERED.

Puno, (Chairman), Panganiban, Sandoval-Gutierrez, and Carpio-Morales, JJ., concur

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