FIRST DIVISION

[G.R. No. L-9996. October 15, 1957.]

EUFEMIA EVANGELISTA, MANUELA EVANGELISTA and FRANCISCA

EVANGELISTA, Petitioners, v. THE COLLECTOR OF INTERNAL REVENUE and THE COURT OF
TAX APPEALS, Respondents.

Santiago F. Alidio and Angel S. Dakila, Jr. for Petitioner.

Solicitor General Ambrosio Padilla, Assistant Solicitor General Esmeraldo Umali and
Solicitor Felicisimo R. Rosete for the respondents.

SYLLABUS

1. TAXATION; TAX ON CORPORATIONS INCLUDES ORGANIZATION WHICH ARE NOT

NECESSARY PARTNERSHIP. "Corporations" strictly speaking are distinct and different
from "partnership." When our Internal Revenue Code includes "partnership" among the
entities subject to the tax on "corporations", it must be allude to organization which are
not necessarily "partnership" in the technical sense of the term.

2. ID.; DULY REGISTERED GENERAL PARTNERSHIP ARE EXEMPTED FROM THE TAX UPON
CORPORATIONS. Section 24 of the Internal Revenue Code exempts from the tax
imposed upon corporations "duly registered general partnership", which constitute
precisely one of the most typical form of partnership in this jurisdiction.

3. ID.; CORPORATION INCLUDES PARTNERSHIP NO MATTER HOW ORGANIZED. As

defined in section 84 (b) of the Internal Revenue Code "the term corporation includes
partnership, no matter how created or organized." This qualifying expression clearly
indicates that a joint venture need not be undertaken in any of the standards form, or
conformity with the usual requirements of the law on partnerships, in order that one
could be deemed constituted for the purposes of the tax on corporations.

4. ID.; CORPORATIONS INCLUDES "JOINT ACCOUNT" AND ASSOCIATIONS WITHOUT LEGAL

PERSONALITY. Pursuant to Section 84 (b) of the Internal Revenue Code, the term
"corporations" includes, among the others, "joint accounts (cuenta en participacion)"
and "associations", none of which has a legal personality of its own independent of that
of its members. For purposes of the tax on corporations, our National Internal Revenue
Code includes these partnership. with the exception only of duly registered general
partnership. within the purview of the term "corporations." Held: That the petitioners in
the case at bar, who are engaged in real estate transactions for monetary gain and
divide the same among themselves, constitute a partnership, so far as the said Code is
concerned, and are subject to the income tax for the corporation.

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5. ID.; CORPORATION; PARTNERSHIP WITHOUT LEGAL PERSONALITY SUBJECT TO
RESIDENCE TAX ON CORPORATION. The pertinent part of the provision of Section 2 of
Commonwealth Act No. 465 which says: "The term corporation as used in this Act
includes joint-stock company, partnership, joint account (cuentas en participacion),
association or insurance company, no matter how created or organized." is analogous
to that of Section 24 and 84 (b) of our Internal Revenue Code which was approved the
day immediately after the approval of said Commonwealth Act No. 565. Apparently,
the terms "corporation" and "Partnership" are used both statutes with substantially the
same meaning, Held: That the petitioners are subject to the residence tax corporations.

DECISION

CONCEPCION, J.:

This is a petition, filed by Eufemia Evangelista, Manuela Evangelista and Francisca

Evangelista, for review of a decision of the Court of Tax Appeals, the dispositive part of
which reads:jgc:chanrobles.com.ph

"FOR ALL THE FOREGOING, we hold that the petitioners are liable for the income tax,
real estate dealers tax and the residence tax for the years 1945 to 1949, inclusive, in
accordance with the respondents assessment for the same in the total amount of
P6,878.34, which is hereby affirmed and the petition for review filed by petitioners is
hereby dismissed with costs against petitioners."cralaw virtua1aw library

It appears from the stipulation submitted by the parties:jgc:chanrobles.com.ph

"1. That the petitioners borrowed from their father the sum of P59,140.00 which amount
together with their personal monies was used by them for the purpose of buying real
properties;

"2. That on February 2, 1943 they bought from Mrs. Josefina Florentino a lot with an area
of 3,713.40 sq. m. including improvements thereon for the sum of P100,000.00; this
property has an assessed value of P57,517.00 as of 1948;

"3. That on April 3, 1944 they purchased from Mrs. Josefa Oppus 21 parcels of land with
an aggregate area of 3,718.40 sq. m. including improvements thereon for P18,000.00;
this property has an assessed value of P8,255.00 as of 1948;

"4. That on April 23, 1944 they purchased from the Insular Investments, Inc., a lot of 4,358
sq. m. including improvements thereon for P108,825.00. This property has an assessed
value of P4,983.00 as of 1943;

"5. That on April 28, 1944 they bought from Mrs. Valentin Afable a lot of 8,371 sq. m.
including improvements thereon for P237,234.14. This property has an assessed value of
P59,140.00 as of 1948;

2|Page
"6. That in a document dated August 16, 1945, they appointed their brother Simeon
Evangelista to manage their properties with full power to lease; to collect and receive
rents; to issue receipts therefor; in default of such payment, to bring suits against the
defaulting tenant; to sign all letters, contracts, etc., for and in their behalf, and to
endorse and deposit all notes and checks for them;

"7. That after having bought the above-mentioned real properties, the petitioners had
the same rented or leased to various tenants;

"8. That from the month of March, 1945 up to and including December, 1945, the total
amount collected as rents on their real properties was P9,599.00 while the expenses
amounted to P3,650.00 thereby leaving them a net rental income of P5,948.33;

"9. That in 1946, they realized a gross rental income in the sum of P24,786.30, out of
which amount was deducted the sum of P16,288.27 for expenses thereby leaving them
a net rental income of P7,498.13;

"10. That in 1948 they realized a gross rental income of P17,453.00 out of the which
amount was deducted the sum of P4,837.65 as expenses, thereby leaving them a net
rental income of P12,615.35."cralaw virtua1aw library

It further appears that on September 24, 19a4, respondent Collector of Internal

Revenue demanded the payment of income tax on corporations, real estate dealers
fixed tax and corporation residence tax for the years 1945-1949, computed, according
to the assessments made by said officer, as follows:chanrob1es virtual 1aw library

INCOME TAXES

1945. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .P614.84

1946. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,144.71

1947. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .910.34

1948. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,912.30

1949. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,575.90

_______________

Total including surcharge and compromise P6,157.09

REAL ESTATE DEALERS FIXED TAX

1946. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .P37.50

1947. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150.00

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1948. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150.00

1949. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150.00

____________

Total including penalty P527.50

RESIDENCE TAXES OF CORPORATION

1945. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .P38.75

1946. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38.75

1947. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38.75

1948. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38.75

1949. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38.75

______________

Total including surchage P193.75

TOTAL TAXES DUE P6,878.34

Said letter of demand and the corresponding assessments were delivered to petitioners
on December 3, 1954, whereupon they instituted the present case in the Court of Tax
Appeals, with a prayer that "the decision of the respondent contained in his letter of
demand dated September 24, 1954" be reversed, and that they be absolved from the
payment of the taxes in question, with costs against the Respondent.

After appropriate proceedings, the Court of Tax Appeals rendered the above-
mentioned decision for the respondent, and, a petition for reconsideration and new
trial having been subsequently denied, the case is now before Us for review at the
instance of the petitioners.

The issue in this case is whether petitioners are subject to the tax on corporations
provided for in section 24 of Commonwealth Act No. 466, otherwise known as the
National Internal Revenue Code, as well as to the residence tax for corporations and
the real estate dealers fixed tax. With respect to the tax on corporations, the issue
hinges on the meaning of the terms "corporation" and "partnership", as used in sections
24 and 84 of said Code, the pertinent parts of which read:jgc:chanrobles.com.ph

"SEC. 24. Rate of tax on corporations. There shall be levied, assessed, collected, and
paid annually upon the total net income received in the preceding taxable year from
all sources by every corporation organized in, or existing under the laws of the

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Philippines, no matter how created or organized but not including duly registered
general co-partnerships (compaias colectivas), a tax upon such income equal to the
sum of the following: . . . ."cralaw virtua1aw library

"Sec. 84(b). The term corporation includes partnerships, no matter how created or
organized, joint-stock companies, joint accounts (cuentas en participacion),
associations or insurance companies, but does not include duly registered general
copartnerships (compaias colectivas)."cralaw virtua1aw library

Article 1767 of the Civil Code of the Philippines provides:jgc:chanrobles.com.ph

"By the contract of partnership two or more persons bind themselves to contribute
money, property, or industry to a common fund, with the intention of dividing the profits
among themselves."cralaw virtua1aw library

Pursuant to this article, the essential elements of a partnership are two, namely: (a) an
agreement to contribute money, property or industry to a common fund; and (b) intent
to divide the profits among the contracting parties. The first element is undoubtedly
present in the case at bar, for, admittedly, petitioners have agreed to, and did,
contribute money and property to a common fund. Hence, the issue narrows down to
their intent in acting as they did. Upon consideration of all the facts and circumstances
surrounding the case, we are fully satisfied that their purpose was to engage in real
estate transactions for monetary gain and then divide the same among themselves,
because:chanrob1es virtual 1aw library

1. Said common fund was not something they found already in existence. It was not a
property inherited by them pro indiviso. They created it purposely. What is more they
jointly borrowed a substantial portion thereof in order to establish said common fund.

2. They invested the same, not merely in one transaction, but in a series of transactions.
On February 2, 1943, they bought a lot for P100,000.00. On April 3, 1944, they purchased
21 lots for P18,000.000. This was soon followed, on April 23, 1944, by the acquisition of
another real estate for P108,825.00. Five (5) days later (April 28, 1944), they got a fourth
lot for P237,234.14. The number of lots (24) acquired and transactions undertaken, as
well as the brief interregnum between each, particularly the last three purchases, is
strongly indicative of a pattern or common design that was not limited to the
conservation and preservation of the aforementioned common fund or even of the
property acquired by petitioners in February, 1943. In other words, one cannot but
perceive a character of habituality peculiar to business transactions engaged in for
purposes of gain.

3. The aforesaid lots were not devoted to residential purposes, or to other personal uses,
of petitioners herein. The properties were leased separately to several persons, who,
from 1945 to 1948 inclusive, paid the total sum of P70,068.30 by way of rentals.
Seemingly, the lots are still being so let, for petitioners do not even suggest that there
has been any change in the utilization thereof.

4. Since August, 1945, the properties have been under the management of one person,

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namely, Simeon Evangelista, with full power to lease, to collect rents, to issue receipts,
to bring suits, to sign letters and contracts, and to indorse and deposit notes and
checks. Thus, the affairs relative to said properties have been handled as if the same
belonged to a corporation or business enterprise operated for profit.

5. The foregoing conditions have existed for more than ten (10) years, or, to be exact,
over fifteen (15) years, since the first property was acquired, and over twelve (12) years,
since Simeon Evangelista became the manager.

6. Petitioners have not testified or introduced any evidence, either on their purpose in
creating the set up already adverted to, or on the causes for its continued existence.
They did not even try to offer an explanation therefor.

Although, taken singly, they might not suffice to establish the intent necessary to
constitute a partnership, the collective effect of these circumstances is such as to leave
no room for doubt on the existence of said intent in petitioners herein. Only one or two
of the aforementioned circumstances were present in the cases cited by petitioners
herein, and, hence, those cases are not in point.

Petitioners insist, however, that they are mere co-owners, not copartners, for, in
consequence of the acts performed by them, a legal entity, with a personality
independent of that of its members, did not come into existence, and some of the
characteristics of partnerships are lacking in the case at bar. This pretense was correctly
rejected by the Court of Tax Appeals.

To begin with, the tax in question is one imposed upon "corporations", which, strictly
speaking, are distinct and different from "partnerships." When our Internal Revenue
Code includes "partnerships" among the entities subject to the tax on "corporations",
said Code must allude, therefore, to organizations which are not necessarily
"partnerships", in the technical sense of the term. Thus, for instance, section 24 of said
Code exempts from the aforementioned tax "duly registered general partnerships",
which constitute precisely one of the most typical forms of partnerships in this
jurisdiction. Likewise, as defined in section 84(b) of said Code, "the term corporation
includes partnerships, no matter how created or organized." This qualifying expression
clearly indicates that a joint venture need not be undertaken in any of the standard
forms, or in conformity with the usual requirements of the law on partnerships, in order
that one could be deemed constituted for purposes of the tax on corporations. Again,
pursuant to said section 84(b), the term "corporation" includes, among other, "joint
accounts, (cuentas en participacion)" and "associations", none of which has a legal
personality of its own, independent of that of its members. Accordingly, the lawmaker
could not have regarded that personality as a condition essential to the existence of
the partnerships therein referred to. In fact, as above stated, "duly registered general
copartner ships" which are possessed of the aforementioned personality have
been expressly excluded by law (sections 24 and 84 [b]) from the connotation of the
term "corporation." It may not be amiss to add that petitioners allegation to the effect
that their liability in connection with the leasing of the lots above referred to, under the
management of one person even if true, on which we express no opinion tends to
increase the similarity between the nature of their venture and that of corporations,

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and is, therefore, an additional argument in favor of the imposition of said tax on
corporations.

Under the Internal Revenue Laws of the United States, "corporations" are taxed
differently from "partnerships." By specific provision of said laws, such "corporations"
include "associations, joint-stock companies and insurance companies." However, the
term "association" is not used in the aforementioned laws

". . . in any narrow or technical sense. It includes any organization, created for the
transaction of designated affairs, or the attainment of some object, which, like a
corporation, continues notwithstanding that its members or participants change, and
the affairs of which, like corporate affairs, are conducted by a single individual, a
committee, a board, or some other group, acting in a representative capacity. It is
immaterial whether such organization is created by an agreement, a declaration of
trust, a statute, or otherwise. It includes a voluntary association, a joint-stock corporation
or company, a business trusts a Massachusetts trust, a common law trust, and
investment trust (whether of the fixed or the management type), an interinsurance
exchange operating through an attorney in fact, a partnership association, and any
other type of organization (by whatever name known) which is not, within the meaning
of the Code, a trust or an estate, or a partnership." (7A Mertens Law of Federal Income
Taxation, p. 788; italics ours.)

Similarly, the American Law.

". . . provides its own concept of a partnership. Under the term partnership it includes
not only a partnership as known at common law but, as well, a syndicate, group, pool,
joint venture, or other unincorporated organization which carries on any business,
financial operation, or venture, and which is not, within the meaning of the Code, a
trust, estate, or a corporation. . . . ." (7A Mertens Law of Federal Income Taxation, p.
789; italics ours.)

"The term partnership includes a syndicate, group, pool, joint venture or other
unincorporated organization, through or by means of which any business, financial
operation, or venture is carried on, . . . ." (8 Mertens Law of Federal Income Taxation, p.
562 Note 63; italics ours.)

For purposes of the tax on corporations, our National Internal Revenue Code, includes
these partnerships with the exception only of duly registered general copartnerships
within the purview of the term "corporation." It is, therefore, clear to our mind that
petitioners herein constitute a partnership, insofar as said Code is concerned, and are
subject to the income tax for corporations.

As regards the residence tax for corporations, section 2 of Commonwealth Act No. 465
provides in part:jgc:chanrobles.com.ph

"Entities liable to residence tax. Every corporation, no matter how created or

organized, whether domestic or resident foreign, engaged in or doing business in the
Philippines shall pay an annual residence tax of five pesos and an annual additional tax

7|Page
which, in no case, shall exceed one thousand pesos, in accordance with the following
schedule: . . .

"The term corporation as used in this Act includes joint-stock company, partnership,
joint account (cuentas en participacion), association or insurance company, no matter
how created or organized." (italics ours.)

Considering that the pertinent part of this provision is analogous to that of sections 24
and 84(b) of our National Internal Revenue Code (Commonwealth Act No. 466), and
that the latter was approved on June 15, 1939, the day immediately after the approval
of said Commonwealth Act No. 465 (June 14, 1939), it is apparent that the terms
"corporation" and "partnership" are used in both statutes with substantially the same
meaning. Consequently, petitioners are subject, also, to the residence tax for
corporations.

Lastly, the records show that petitioners have habitually engaged in leasing the
properties above mentioned for a period of over twelve years, and that the yearly gross
rentals of said properties from 1945 to 1948 ranged from P9,599 to P17,453. Thus, they
are subject to the tax provided in section 193 (q) of our National Internal Revenue
Code, for "real estate dealers," inasmuch as, pursuant to section 194(s)
thereof:jgc:chanrobles.com.ph

"Real estate dealer includes any person engaged in the business of buying, selling,
exchanging, leasing, or renting property or his own account as principal and holding
himself out as a full or part- time dealer in real estate or as an owner of rental property
or properties rented or offered to rent for an aggregate amount of three thousand
pesos or more a year. . . . ." (Italics ours.)

Wherefore, the appealed decision of the Court of Tax Appeals is hereby affirmed with
costs against the petitioners herein. It is so ordered.

Paras, C.J., Bengzon, Padilla, Reyes, A., Reyes, J. B. L., Endencia and Felix, JJ., concur.

Separate Opinions

BAUTISTA ANGELO, J., concurring:chanrob1es virtual 1aw library

I agree with the opinion that petitioners have actually contributed money to a
common fund with express purpose of engaging in real estate business for profit. The
series of transactions which they had undertaken attest to this. This appears in the
following portion of of the decision:jgc:chanrobles.com.ph

"2. They invested the same, not merely in one transaction, but in a series of transactions.
On February 2, 1943, they bought a lot for P100,000. On April 3, 1944, they purchased 21
lots for P18,000. This was soon followed on April 23, 1944, by the acquisition of another
real estate for P108,825. Five (5) days later (April 28, 1944), they got a fourth lot for
P237,234.14. The number of lots (24) acquired and transactions undertaken, as well as

8|Page
the brief interregnum between each, particularly the last three purchases, is strongly
indicative of a pattern or common design that was not limited to the conservation and
preservation of the afore-mentioned common fund or even of the property acquired
by petitioner in February, 1943. In other words, one cannot but perceive a character of
habituality peculiar to business transactions engaged in for purposes of gain."cralaw
virtua1aw library

I wish however to make the following observation: Article 1769 of the new Civil Code
lays down the rule for determining when a transaction should be deemed a partnership
or a co-ownership. Said article paragraphs 2 and 3, provides:jgc:chanrobles.com.ph

"(2) Co-ownership or co-possession does not of itself establish a partnership, whether

such co-owners or co-possessors do or do not share any profits made by the use of the
property;

"(3) The sharing of gross returns does not of itself establish a partnership, whether or not
the persons sharing them have a joint or common right or interest in any property from
which the returns are derived;"

From the above it appears that the fact that those who agree to form a co-ownership
share or do not share any profits made by the use of the property held in common does
not convert their venture into a partnership Or the sharing of the gross returns does not
of itself establish a partnership whether or not the persons sharing therein have a joint or
common right or interest in the property. This only means that, aside from the
circumstance of profit, the presence of other elements constituting partnership is
necessary, such as the clear intent to form a partnership, the existence of a juridical
personality different from that of the individual partners, and the freedom to transfer or
assign any interest in the property by one with the consent of the others (Padilla, Civil
Code of the Philippines Annotated, Vol. I, 1953 ed., pp. 635-636).

It is evident that an isolated transaction whereby two or more persons contribute funds
to buy certain real estate for profit in the absence of other circumstances showing a
contrary intention cannot be considered a partnership.

"Persons who contribute property or funds for a common enterprise and agree to share
the gross returns of that enterprise in proportion to their contribution, but who severally
retain the title to their respective contribution, are not thereby rendered partners. They
have no common stock or capital, and no community of interest as principal
proprietors in the business itself which the proceeds derived." (Elements of the law of
Partnership by Floyd R. Mechem, 2n Ed., section 83, p. 74.)

"A joint purchase of land, by two, does not constitute a copartnership in respect
thereto; nor does an agreement to share the profits and losses on the sale of land
create a partnership; the parties are only tenants in common." (Clark v. Sideway, 142 U.
S. 682, 12 S. Ct. 327, 35 L. Ed., 1157.)

"Where plaintiff, his brother, and another agreed to become owners of a single tract of
realty, holding as tenants in common, and to divide the profits of disposing of it, the

9|Page
brother and the other not being entitled to share in plaintiffs commissions, no
partnership existed as between the three parties, whatever their relation may have
been as to third parties." (Magee v. Magee, 123 N. E. 673, 233 Mass. 341.)

"In order to constitute a partnership inter sese there must be: (a) An intent to form the
same; (b) generally a participating in both profits and losses; (c) and such a community
of interest, as far as third persons are concerned as enables each party to make
contract, manage the business, and dispose of the whole property." (Municipal Paving
Co. v. Herring, 150 P. 1067, 50 Ill. 470.)

"The common ownership of property does not itself create a partnership between the
owners, though they may use it for purpose of making gains; and they may, without
becoming partners, agree among themselves as to the management and use of such
property and the application of the proceeds therefrom." (Spurlock v. Wilson, 142 S. W.
363, 160 No. App. 14.)

This is impliedly recognized in the following portion of the decision: "Although, taken
singly, they might not suffice to establish the intent necessary to constitute a
partnership, the collective effect of these circumstances (referring to the series of
transactions) such as to leave no room for doubt on the existence of said intent in
petitioners herein."

10 | P a g e
 Republic of the Philippines
SUPREME COURT
Manila

EN BANC

G.R. Nos. L-18169, L-18262 & L-21434 July 31, 1964

COMMISSIONER OF INTERNAL REVENUES, petitioner,

vs.
V.E. LEDNICKY and MARIA VALERO LEDNICKY, respondents.

Office of the Solicitor General for petitioner.

Ozaeta, Gibbs and Ozaeta for respondents.

REYES, J.B.L., J.:

The above-captioned cases were elevated to this Court under separate petitions by the
Commissioner for review of the corresponding decisions of the Court of Tax Appeals.
Since these cases involve the same parties and issues akin to each case presented, they
are herein decided jointly.

The respondents, V. E. Lednicky and Maria Valero Lednicky, are husband and wife,
respectively, both American citizens residing in the Philippines, and have derived all
their income from Philippine sources for the taxable years in question.

In compliance with local law, the aforesaid respondents, on 27 March 1957, filed their
income tax return for 1956, reporting therein a gross income of P1,017,287. 65 and a
net income of P733,809.44 on which the amount of P317,395.4 was assessed after
deducting P4,805.59 as withholding tax. Pursuant to the petitioner's assessment
notice, the respondents paid the total amount of P326,247.41, inclusive of the
withheld taxes, on 15 April 1957.

On 17 March 1959, the respondents Lednickys filed an amended income tax return for
1956. The amendment consists in a claimed deduction of P205,939.24 paid in 1956 to
the United States government as federal income tax for 1956. Simultaneously with the
filing of the amended return, the respondents requested the refund of P112,437.90.

When the petitioner Commissioner of Internal Revenue failed to answer the claim for
refund, the respondents filed their petition with the Tax Court on 11 April 1959 as
CTA Case No. 646, which is now G. R. No. L-18286 in the Supreme Court.

11 | P a g e
G. R. No. L-18169 (formerly CTA Case No. 570) is also a claim for refund in the
amount of P150,269.00, as alleged overpaid income tax for 1955, the facts of which
are as follows:

On 28 February 1956, the same respondents-spouses filed their domestic income tax
return for 1955, reporting a gross income of P1,771,124.63 and a net income of
P1,052,550.67. On 19 April 1956, they filed an amended income tax return, the
amendment upon the original being a lesser net income of P1,012,554.51, and, on the
basis of this amended return, they paid P570,252.00, inclusive of withholding taxes.
After audit, the petitioner determined a deficiency of P16,116.00, which amount, the
respondents paid on 5 December 1956.

Back in 1955, however, the Lednickys filed with the U.S. Internal Revenue Agent in
Manila their federal income tax return for the years 1947, 1951, 1952, 1953, and 1954
on income from Philippine sources on a cash basis. Payment of these federal income
taxes, including penalties and delinquency interest in the amount of P264,588.82,
were made in 1955 to the U.S. Director of Internal Revenue, Baltimore, Maryland,
through the National City Bank of New York, Manila Branch. Exchange and bank
charges in remitting payment totaled P4,143.91.

Wherefore, the parties respectfully pray that the foregoing stipulation of facts be
admitted and approved by this Honorable Court, without prejudice to the parties
adducing other evidence to prove their case not covered by this stipulation of
facts. 1wph1.t

On 11 August 1958, the said respondents amended their Philippine income tax return
for 1955 to include the following deductions:

U.S. Federal income taxes P471,867.32

Interest accrued up to May 15, 1955 40,333.92
Exchange and bank charges 4,143.91

Total P516,345.15

and therewith filed a claim for refund of the sum of P166,384.00, which was later
reduced to P150,269.00.

The respondents Lednicky brought suit in the Tax Court, which was docketed therein
as CTA Case No. 570.

12 | P a g e
In G. R. No. 21434 (CTA Case No. 783), the facts are similar, but refer to respondents
Lednickys' income tax return for 1957, filed on 28 February 1958, and for which
respondents paid a total sum of P196,799.65. In 1959, they filed an amended return
for 1957, claiming deduction of P190,755.80, representing taxes paid to the U.S.
Government on income derived wholly from Philippine sources. On the strength
thereof, respondents seek refund of P90 520.75 as overpayment. The Tax Court again
decided for respondents.

The common issue in all three cases, and one that is of first impression in this
jurisdiction, is whether a citizen of the United States residing in the Philippines, who
derives income wholly from sources within the Republic of the Philippines, may
deduct from his gross income the income taxes he has paid to the United States
government for the taxable year on the strength of section 30 (C-1) of the Philippine
Internal Revenue Code, reading as follows:

SEC. 30. Deduction from gross income. In computing net income there shall
be allowed as deductions

(a) ...

(b) ...

(c) Taxes:

(1) In general. Taxes paid or accrued within the taxable year,

except

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed

by the authority of any foreign country; but this deduction
shall be allowed in the case of a taxpayer who does not
signify in his return his desire to have to any extent the
benefits of paragraph (3) of this subsection (relating to
credit for foreign countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending

to increase the value of the property assessed. (Emphasis
supplied)

13 | P a g e
 The Tax Court held that they may be deducted because of the undenied fact that
the respondent spouses did not "signify" in their income tax return a desire to
avail themselves of the benefits of paragraph 3 (B) of the subsection, which
reads:

Par. (c) (3) Credits against tax for taxes of foreign countries. If the
taxpayer signifies in his return his desire to have the benefits of this
paragraph, the tax imposed by this Title shall be credited with

(A) ...;

(B) Alien resident of the Philippines. In the case of an alien

resident of the Philippines, the amount of any such taxes paid or
accrued during the taxable year to any foreign country, if the
foreign country of which such alien resident is a citizen or subject,
in imposing such taxes, allows a similar credit to citizens of the
Philippines residing in such country;

It is well to note that the tax credit so authorized is limited under paragraph 4
(A and B) of the same subsection, in the following terms:

Par. (c) (4) Limitation on credit. The amount of the credit taken under
this section shall be subject to each of the following limitations:

(A) The amount of the credit in respect to the tax paid or accrued
to any country shall not exceed the same proportion of the tax
against which such credit is taken, which the taxpayer's net
income from sources within such country taxable under this Title
bears to his entire net income for the same taxable year; and

(B) The total amount of the credit shall not exceed the same
proportion of the tax against which such credit is taken, which the
taxpayer's net income from sources without the Philippines
taxable under this Title bears to his entire net income for the same
taxable year.

We agree with appellant Commissioner that the Construction and

wording of Section 30 (c) (1) (B) of the Internal Revenue Act shows the
law's intent that the right to deduct income taxes paid to foreign
government from the taxpayer's gross income is given only as an
alternative or substitute to his right to claim a tax credit for such foreign
income taxes under section 30 (c) (3) and (4); so that unless the alien

14 | P a g e
 resident has a right to claim such tax credit if he so chooses, he is
precluded from deducting the foreign income taxes from his gross
income. For it is obvious that in prescribing that such deduction shall be
allowed in the case of a taxpayer who does not signify in his return his
desire to have to any extent the benefits of paragraph (3) (relating to
credits for taxes paid to foreign countries), the statute assumes that the
taxpayer in question also may signify his desire to claim a tax credit and
waive the deduction; otherwise, the foreign taxes would always be
deductible, and their mention in the list of non-deductible items in
Section 30(c) might as well have been omitted, or at least expressly
limited to taxes on income from sources outside the Philippine Islands.

Had the law intended that foreign income taxes could be deducted from
gross income in any event, regardless of the taxpayer's right to claim a
tax credit, it is the latter right that should be conditioned upon the
taxpayer's waiving the deduction; in which Case the right to reduction
under subsection (c-1-B) would have been made absolute or
unconditional (by omitting foreign taxes from the enumeration of non-
deductions), while the right to a tax credit under subsection (c-3) would
have been expressly conditioned upon the taxpayer's not claiming any
deduction under subsection (c-1). In other words, if the law had been
intended to operate as contended by the respondent taxpayers and by the
Court of Tax Appeals section 30 (subsection (c-1) instead of providing
as at present:

SEC. 30. Deduction from gross income. In computing net income there shall
be allowed as deductions

(a) ...

(b) ...

(c) Taxes:

(1) In general. Taxes paid or accrued within the taxable year,

except

(A) The income tax provided for under this Title;

(B) Income, war-profits, and excess profits taxes imposed

by the authority of any foreign country; but this deduction
shall be allowed in the case of a taxpayer who does not

15 | P a g e
 signify in his return his desire to have to any extent the
benefits of paragraph (3) of this subsection (relating to
credit for taxes of foreign countries);

(C) Estate, inheritance and gift taxes; and

(D) Taxes assessed against local benefits of a kind tending

to increase the value of the property assessed.

would have merely provided:

SEC. 30. Decision from grow income. In computing net income there shall
be allowed as deductions:

(a) ...

(b) ...

(c) Taxes paid or accrued within the taxable year, EXCEPT

(A) The income tax provided for in this Title;

(B) Omitted or else worded as follows:

Income, war profits and excess profits taxes imposed by authority of any
foreign country on income earned within the Philippines if the taxpayer
does not claim the benefits under paragraph 3 of this subsection;

(C) Estate, inheritance or gift taxes;

(D) Taxes assessed against local benefits of a kind tending to increase

the value of the property assessed.

while subsection (c-3) would have been made conditional in the following or
equivalent terms:

(3) Credits against tax for taxes of foreign countries. If the taxpayer has not
deducted such taxes from his gross income but signifies in his return his desire
to have the benefits of this paragraph, the tax imposed by Title shall be credited
with ... (etc.).

Petitioners admit in their brief that the purpose of the law is to prevent the taxpayer
from claiming twice the benefits of his payment of foreign taxes, by deduction from
16 | P a g e
gross income (subs. c-1) and by tax credit (subs. c-3). This danger of double credit
certainly can not exist if the taxpayer can not claim benefit under either of these
headings at his option, so that he must be entitled to a tax credit (respondent taxpayers
admittedly are not so entitled because all their income is derived from Philippine
sources), or the option to deduct from gross income disappears altogether.

Much stress is laid on the thesis that if the respondent taxpayers are not allowed to
deduct the income taxes they are required to pay to the government of the United
States in their return for Philippine income tax, they would be subjected to double
taxation. What respondents fail to observe is that double taxation becomes obnoxious
only where the taxpayer is taxed twice for the benefit of the same governmental
entity (cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co.
vs. Meer, 89 Phil. 357). In the present case, while the taxpayers would have to pay
two taxes on the same income, the Philippine government only receives the proceeds
of one tax. As between the Philippines, where the income was earned and where the
taxpayer is domiciled, and the United States, where that income was not earned and
where the taxpayer did not reside, it is indisputable that justice and equity demand that
the tax on the income should accrue to the benefit of the Philippines. Any relief from
the alleged double taxation should come from the United States, and not from the
Philippines, since the former's right to burden the taxpayer is solely predicated on his
citizenship, without contributing to the production of the wealth that is being taxed.

Aside from not conforming to the fundamental doctrine of income taxation that the
right of a government to tax income emanates from its partnership in the production of
income, by providing the protection, resources, incentive, and proper climate for such
production, the interpretation given by the respondents to the revenue law provision in
question operates, in its application, to place a resident alien with only domestic
sources of income in an equal, if not in a better, position than one who has both
domestic and foreign sources of income, a situation which is manifestly unfair and
short of logic.

Finally, to allow an alien resident to deduct from his gross income whatever taxes he
pays to his own government amounts to conferring on the latter the power to reduce
the tax income of the Philippine government simply by increasing the tax rates on the
alien resident. Everytime the rate of taxation imposed upon an alien resident is
increased by his own government, his deduction from Philippine taxes would
correspondingly increase, and the proceeds for the Philippines diminished, thereby
subordinating our own taxes to those levied by a foreign government. Such a result is
incompatible with the status of the Philippines as an independent and sovereign state.

17 | P a g e
IN VIEW OF THE FOREGOING, the decisions of the Court of Tax Appeals are
reversed, and, the disallowance of the refunds claimed by the respondents Lednicky is
affirmed, with costs against said respondents-appellees.

Bengzon, C.J., Padilla, Bautista Angelo, Labrador, Concepcion, Paredes, Regala and
Makalintal, JJ., concur.

United States Supreme Court

EISNER v. MACOMBER, (1920)
No. 318
Argued: April 16, 1919 Decided: March 8, 1920
[252 U.S. 189, 190] Mr. Assistant Attorney General Frierson, for plaintiff in error.

[252 U.S. 189, 194] Messrs. Charles E. Hughes and George Welwood Murray, both of
New York City, for defendant in error.

[252 U.S. 189, 199]

Mr. Justice PITNEY delivered the opinion of the Court.

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

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

The facts, in outline, are as follows:

On January 1, 1916, the Standard Oil Company of California, a corporation of that

state, out of an authorized capital stock of $100,000, 000, had shares of stock
outstanding, par value $100 each, amounting in round figures to $50,000,000. In
addition, it had surplus and undivided profits invested in plant, property, and business
and required for the purposes of the corporation, amounting to about $45,000,000, of
which about $20,000,000 had been earned prior to March 1, 1913, the balance
thereafter. In January, 1916, in order to readjust the capitalization, the board of
directors decided to issue additional shares sufficient to constitute a stock dividend of
50 per cent. of the outstanding stock, and to transfer from surplus account to capital
stock account an amount equivalent to such issue. Appropriate resolutions were
adopted, an amount equivalent to the par value of the proposed new stock was

18 | P a g e
transferred accordingly, and the new stock duly issued against it and divided among
the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock, received
certificates for 1,100 additional [252 U.S. 189, 201] shares, of which 18.07 per cent., or
198.77 shares, par value $19,877, were treated as representing surplus earned between
March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under
protest, a tax imposed under the Revenue Act of 1916, based upon a supposed
income of $ 19,877 because of the new shares; and an appeal to the Commissioner of
Internal Revenue having been disallowed, she brought action against the Collector to
recover the tax. In her complaint she alleged the above facts, and contended that in
imposing such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3, and article 1, 9,
cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned
according to population, and that the stock dividend was not income within the
meaning of the Sixteenth Amendment. A general demurrer to the complaint was
overruled upon the authority of Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A.
1918D, 254; and, defendant having failed to plead further, final judgment went against
him. To review it, the present writ of error is prosecuted.

The case was argued at the last term, and reargued at the present term, both orally
and by additional briefs.

We are constrained to hold that the judgment of the District Court must be affirmed:
First, because the question at issue is controlled by Towne v. Eisner, supra; secondly,
because a re-examination of the question with the additional light thrown upon it by
elaborate arguments, has confirmed the view that the underlying ground of that
decision is sound, that it disposes of the question here presented, and that other
fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against
surplus earned prior to January 1, 1913, was taxable against the stockholder under the
Act of October 3, 1913 (38 Stat. 114, 166, c. 16 ), which provided (section B, p. 167) that
net income should include 'dividends,' and also 'gains or profits and income
derived [252 U.S. 189, 202] from any source whatever.' Suit having been brought by a
stockholder to recover the tax assessed against him by reason of the dividend, the
District Court sustained a demurrer to the complaint. 242 Fed. 702. The court treated the
construction of the act as inseparable from the interpretation of the Sixteenth
Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601 ,
15 Sup. Ct. 912, and quoted the Amendment, proceeded very properly to say (242 Fed.
704):

'It is manifest that the stock dividend in question cannot be reached by the Income Tax
Act and could not, even though Congress expressly declared it to be taxable as
income, unless it is in fact income.'
It declined, however, to accede to the contention that in Gibbons v. Mahon, 136 U.S.
549 , 10 Sup. Ct. 1057, 'stock dividends' had received a definition sufficiently clear to be
controlling, treated the language of this court in that case as obiter dictum in respect of
the matter then before it (242 Fed. 706), and examined the question as res nova, with

19 | P a g e
the result stated. When the case came here, after overruling a motion to dismiss made
by the government upon the ground that the only question involved was the
construction of the statute and not its constitutionality, we dealt upon the merits with
the question of construction only, but disposed of it upon consideration of the essential
nature of a stock dividend disregarding the fact that the one in question was based
upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not
only so, but we rejected the reasoning of the District Court, saying ( 245 U.S. 426 , 38
Sup. Ct. 159, L. R. A. 1918D, 254):

'Notwithstanding the thoughtful discussion that the case received below we cannot
doubt that the dividend was capital as well for the purposes of the Income Tax Law as
for distribution between tenant for life and remainderman. What was said by this court
upon the latter question is equally true for the former. 'A stock dividend really takes
nothing from the property of the corporation, and adds nothing to the [252 U.S. 189,
203] interests of the shareholders. Its property is not diminished, and their interests are
not increased. ... The proportional interest of each shareholder remains the same. The
only change is in the evidence which represents that interest, the new shares and the
original shares together representing the same proportional interest that the original
shares represented before the issue of the new ones.' Gibbons v. Mahon, 136 U.S. 549,
559 , 560 S. [10 Sup. Ct. 1057]. In short, the corporation is no poorer and the stockholder
is no richer than they were before. Logan County v. United States, 169 U.S. 255 , 261 [18
Sup. Ct. 361]. If the plaintiff gained any small advantage by the change, it certainly was
not an advantage of $417,450, the sum upon which he was taxed. ... What has
happened is that the plaintiff's old certificates have been split up in effect and have
diminished in value to the extent of the value of the new.'
This language aptly answered not only the reasoning of the District Court but the
argument of the Solicitor General in this court, which discussed the essential nature of a
stock dividend. And if, for the reasons thus expressed, such a dividend is not to be
regarded as 'income' or 'dividends' within the meaning of the act of 1913, we are
unable to see how it can be brought within the meaning of 'incomes' in the Sixteenth
Amendment; it being very clear that Congress intended in that act to exert its power to
the extent permitted by the amendment. In Towne v. Eisner it was not contended that
any construction of the statute could make it narrower than the constitutional grant;
rather the contrary.

The fact that the dividend was charged against profits earned before the act of 1913
took effect, even before the amendment was adopted, was neither relied upon nor
alluded to in our consideration of the merits in that case. Not only so, but had we
considered that a stock dividend constituted income in any true sense, it would have
been held taxable under the act of 1913 notwithstanding it was [252 U.S. 189,
204] based upon profits earned before the amendment. We ruled at the same term, in
Lynch v. Hornby, 247 U.S. 339 , 38 Sup. Ct. 543, that a cash dividend extraordinary in
amount, and in Peabody v. Eisner, 247 U.S. 347 , 38 Sup. Ct. 546, that a dividend paid in
stock of another company, were taxable as income although based upon earnings
that accrued before adoption of the amendment. In the former case, concerning
'corporate profits that accumulated before the act took effect,' we declared ( 247 U.S.
343, 344 , 38 S. Sup. Ct. 543, 545 [62 L. Ed. 1149]):

20 | P a g e
'Just as we deem the legislative intent manifest to tax the stockholder with respect to
such accumulations only if and when, and to the extent that, his interest in them comes
to fruition as income, that is, in dividends declared, so we can perceive no
constitutional obstacle that stands in the way of carrying out this intent when dividends
are declared out of a pre-existing surplus. ... Congress was at liberty under the
amendment to tax as income, without apportionment, everything that became
income, in the ordinary sense of the word, after the adoption of the amendment,
including dividends received in the ordinary course by a stockholder from a
corporation, even though they were extraordinary in amount and might appear upon
analysis to be a mere realization in possession of an inchoate and contingent interest
that the stockholder had in a surplus of corporate assets previously existing.'
In Peabody v. Eisner, 247 U.S. 349, 350 , 38 S. Sup. Ct. 546, 547 (62 L. Ed. 1152), we
observed that the decision of the District Court in Towne v. Eisner had been reversed
'only upon the ground that it related to a stock dividend which in fact took nothing
from the property of the corporation and added nothing to the interest of the
shareholder, but merely changed the evidence which represented that interest,' and
we distinguished the Peabody Case from the Towne Case upon the ground that 'the
dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in
specie of a portion of the assets of the Union Pacific.'

Therefore Towne v. Eisner cannot be regarded as turning [252 U.S. 189, 205] upon the
point that the surplus accrued to the company before the act took effect and before
adoption of the amendment. And what we have quoted from the opinion in that case
cannot be regarded as obiter dictum, it having furnished the entire basis for the
conclusion reached. We adhere to the view then expressed, and might rest the present
case there, not because that case in terms decided the constitutional question, for it
did not, but because the conclusion there reached as to the essential nature of a stock
dividend necessarily prevents its being regarded as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the
Revenue Act of 1916 declared (39 Stat. 757 [Comp. St . 6336b]) that a 'stock dividend
shall be considered income, to the amount of its cash value,' we will deal at length with
the constitutional question, incidentally testing the soundness of our previous
conclusion.

The Sixteenth Amendment must be construed in connection with the taxing clauses of
the original Constitution and the effect attributed to them before the amendment was
adopted. In Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601 , 15 Sup. Ct. 912, under the
Act of August 27, 1894 (28 Stat. 509, 553, c. 349, 27), it was held that taxes upon rents
and profits of real estate and upon returns from investments of personal property were
in effect direct taxes upon the property from which such income arose, imposed by
reason of ownership; and that Congress could not impose such taxes without
apportioning them among the states according to population, as required by article 1,
2, cl. 3, and section 9, cl. 4, of the original Constitution.

Afterwards, and evidently in recognition of the limitation upon the taxing power of
Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly
expressing the object to be accomplished:

21 | P a g e
'The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among [252 U.S. 189, 206] the several states,
and without regard to any census or enumeration.'
As repeatedly held, this did not extend the taxing power to new subjects, but merely
removed the necessity which otherwise might exist for an apportionment among the
states of taxes laid on income. Brushaber v. Union Pacific R. R. Co., 240 U.S. 1 , 17-19, 36
Sup. Ct. 236, Ann. Cas. 1917B, 713, L. R. A. 1917D, 414; Stanton v. Baltic Mining Co., 240
U.S. 103 , 112 et seq., 36 Sup. Ct. 278; Peck & Co. v. Lowe,247 U.S. 165, 172 , 173 S., 38
Sup. Ct. 432.

A proper regard for its genesis, as well as its very clear language, requires also that this
amendment shall not be extended by loose construction, so as to repeal or modify,
except as applied to income, those provisions of the Constitution that require an
apportionment according to population for direct taxes upon property, real and
personal. This limitation still has an appropriate and important function, and is not to be
overridden by Congress or disregarded by the courts.

In order, therefore, that the clauses cited from article 1 of the Constitution may have
proper force and effect, save only as modified by the amendment, and that the latter
also may have proper effect, it becomes essential to distinguish between what is and
what is not 'income,' as the term is there used, and to apply the distinction, as cases
arise, according to truth and substance, without regard to form. Congress cannot by
any definition it may adopt conclude the matter, since it cannot by legislation alter the
Constitution, from which alone it derives its power to legislate, and within whose
limitations alone that power can be lawfully exercised.

The fundamental relation of 'capital' to 'income' has been much discussed by

economists, the former being likened to the tree or the land, the latter to the fruit or the
crop; the former depicted as a reservoir supplied from springs, the latter as the outlet
stream, to be measured by its flow during a period of time. For the present purpose we
require only a clear definition of the term 'income,' [252 U.S. 189, 207] as used in
common speech, in order to determine its meaning in the amendment, and, having
formed also a correct judgment as to the nature of a stock dividend, we shall find it
easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's
Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in
two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v.
Howbert, 231 U.S. 399, 415 , 34 S. Sup. Ct. 136, 140 [58 L. Ed. 285]; Doyle v. Mitchell Bros.
Co., 247 U.S. 179, 185 , 38 S. Sup. Ct. 467, 469 [62 L. Ed. 1054]), 'Income may be defined
as the gain derived from capital, from labor, or from both combined,' provided it be
understood to include profit gained through a sale or conversion of capital assets, to
which it was applied in the Doyle Case, 247 U.S. 183, 185 , 38 S. Sup. Ct. 467, 469 (62 L.
Ed. 1054).

Brief as it is, it indicates the characteristic and distinguishing attribute of income

essential for a correct solution of the present controversy. The government, although
basing its argument upon the definition as quoted, placed chief emphasis upon the

22 | P a g e
word 'gain,' which was extended to include a variety of meanings; while the
significance of the next three words was either overlooked or misconceived. 'Derived-
from- capital'; 'the gain-derived-from-capital,' etc. Here we have the essential matter:
not a gain accruing to capital; not a growth or increment of value in the investment;
but a gain, a profit, something of exchangeable value, proceeding from the property,
severed from the capital, however invested or employed, and coming in, being
'derived'-that is, received or drawn by the recipient (the taxpayer) for his separate use,
benefit and disposal- that is income derived from property. Nothing else answers the
description.

The same fundamental conception is clearly set forth in the Sixteenth Amendment-
'incomes, from whatever source derived'-the essential thought being expressed [252
U.S. 189, 208] with a conciseness and lucidity entirely in harmony with the form and
style of the Constitution.

Can a stock dividend, considering its essential character, be brought within the
definition? To answer this, regard must be had to the nature of a corporation and the
stockholder's relation to it. We refer, of course, to a corporation such as the one in the
case at bar, organized for profit, and having a capital stock divided into shares to
which a nominal or par value is attributed.

Certainly the interest of the stockholder is a capital interest, and his certificates of stock
are but the evidence of it. They state the number of shares to which he is entitled and
indicate their par value and how the stock may be transferred. They show that he or his
assignors, immediate or remote, have contributed capital to the enterprise, that he is
entitled to a corresponding interest proportionate to the whole, entitled to have the
property and business of the company devoted during the corporate existence to
attainment of the common objects, entitled to vote at stockholders' meetings, to
receive dividends out of the corporation's profits if and when declared, and, in the
event of liquidation, to receive a proportionate share of the net assets, if any, remaining
after paying creditors. Short of liquidation, or until dividend declared, he has no right to
withdraw any part of either capital or profits from the common enterprise; on the
contrary, his interest pertains not to any part, divisible or indivisible, but to the entire
assets, business, and affairs of the company. Nor is it the interest of an owner in the
assets themselves, since the corporation has full title, legal and equitable, to the whole.
The stockholder has the right to have the assets employed in the enterprise, with the
incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the
right to persist, subject to the risks of the enterprise, and looking only to dividends for his
return. If he desires to dissociate himself[252 U.S. 189, 209] from the company he can
do so only by disposing of his stock.

For bookeeping purposes, the company acknowledges a liability in form to the

stockholders equivalent to the aggregate par value of their stock, evidenced by a
'capital stock account.' If profits have been made and not divided they create
additional bookkeeping liabilities under the head of 'profit and loss,' 'undivided profits,'
'surplus account,' or the like. None of these, however, gives to the stockholders as a
body, much less to any one of them, either a claim against the going concern for any
particular sum of money, or a right to any particular portion of the assets or any share in

23 | P a g e
them unless or until the directors conclude that dividends shall be made and a part of
the company's assets segregated from the common fund for the purpose. The dividend
normally is payable in money, under exceptional circumstances in some other divisible
property; and when so paid, then only (excluding, of course, a possible advantageous
sale of his stock or winding-up of the company) does the stockholder realize a profit or
gain which becomes his separate property, and thus derive income from the capital
that he or his predecessor has invested.

In the present case, the corporation had surplus and undivided profits invested in plant,
property, and business, and required for the purposes of the corporation, amounting to
about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this the
case is not extraordinary. The profits of a corporation, as they appear upon the
balance sheet at the end of the year, need not be in the form of money on hand in
excess of what is required to meet current liabilities and finance current operations of
the company. Often, especially in a growing business, only a part, sometimes a small
part, of the year's profits is in property capable of division; the remainder having been
absorbed in the acquisition of increased plant, [252 U.S. 189, 210] quipment, stock in
trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part
is available for dividends, the balance of the year's profits is carried to the credit of
undivided profits, or surplus, or some other account having like significance. If thereafter
the company finds itself in funds beyond current needs it may declare dividends out of
such surplus or undivided profits; otherwise it may go on for years conducting a
successful business, but requiring more and more working capital because of the
extension of its operations, and therefore unable to declare dividends approximating
the amount of its profits. Thus the surplus may increase until it equals or even exceeds
the par value of the outstanding capital stock. This may be adjusted upon the books in
the mode adopted in the case at bar-by declaring a 'stock dividend.' This, however, is
no more than a book adjustment, in essence not a dividend but rather the opposite; no
part of the assets of the company is separated from the common fund, nothing
distributed except paper certificates that evidence an antecedent increase in the
value of the stockholder's capital interest resulting from an accumulation of profits by
the company, but profits so far absorbed in the business as to render it impracticable to
separate them for withdrawal and distribution. In order to make the adjustment, a
charge is made against surplus account with corresponding credit to capital stock
account, equal to the proposed 'dividend'; the new stock is issued against this and the
certificates delivered to the existing stockholders in proportion to their previous holdings.
This, however, is merely bookkeeping that does not affect the aggregate assets of the
corporation or its outstanding liabilities; it affects only the form, not the essence, of the
'liability' acknowledged by the corporation to its own shareholders, and this through a
readjustment of accounts on one side of the balance sheet only, increasing 'capital
stock' at the expense of [252 U.S. 189, 211] 'SURPLUS'; IT DOES NOT ALTER THE PRE-
EXisting proportionate interest of any stockholder or increase the intrinsic value of his
holding or of the aggregate holdings of the other stockholders as they stood before.
The new certificates simply increase the number of the shares, with consequent dilution
of the value of each share.

A 'stock dividend' shows that the company's accumulated profits have been
capitalized, instead of distributed to the stockholders or retained as surplus available for

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distribution in money or in kind should opportunity offer. Far from being a realization of
profits of the stockholder, it tends rather to postpone such realization, in that the fund
represented by the new stock has been transferred from surplus to capital, and no
longer is available for actual distribution.

The essential and controlling fact is that the stockholder has received nothing out of the
company's assets for his separate use and benefit; on the contrary, every dollar of his
original investment, together with whatever accretions and accumulations have
resulted from employment of his money and that of the other stockholders in the
business of the company, still remains the property of the company, and subject to
business risks which may result in wiping out the entire investment. Having regard to the
very truth of the matter, to substance and not to form, he has recived nothing that
answers the definition of income within the meaning of the Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when
lawfully made, we lay aside the question whether in a particular case a stock dividend
may be authorized by the local law governing the corporation, or whether the
capitalization of profits may be the result of correct judgment and proper business
policy on the part of its management, and a due regard for the interests of the
stockholders. And we are considering the taxability of bona fide stock dividends
only. [252 U.S. 189, 212] We are clear that not only does a stock dividend really take
nothing from the property of the corporation and add nothing to that of the
shareholder, but that the antecedent accumulation of profits evidenced thereby, while
indicating that the shareholder is the richer because of an increase of his capital, at the
same time shows he has not realized or received any income in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock dividend; and
so he may, if he can find a buyer. It is equally true that if he does sell, and in doing so
realizes a profit, such profit, like any other, is income, and so far as it may have arisen
since the Sixteenth Amendment is taxable by Congress without apportionment. The
same would be true were he to sell some of his original shares at a profit. But if a
shareholder sells dividend stock he necessarily disposes of a part of his capital interest,
just as if he should sell a part of his old stock, either before or after the dividend. What
he retains no longer entitles him to the same proportion of future dividends as before
the sale. His part in the control of the company likewise is diminished. Thus, if one
holding $60,000 out of a total $100,000 of the capital stock of a corporation should
receive in common with other stockholders a 50 per cent. stock dividend, and should
sell his part, he thereby would be reduced from a majority to a minority stockholder,
having six-fifteenths instead of six- tenths of the total stock outstanding. A corresponding
and proportionate decrease in capital interest and in voting power would befall a
minority holder should he sell dividend stock; it being in the nature of things impossible
for one to dispose of any part of such an issue without a proportionate disturbance of
the distribution of the entire capital stock, and a like diminution of the seller's
comparative voting power-that 'right preservative of rights' in the control of a
corporation. [252 U.S. 189, 213] Yet, without selling, the shareholder, unless possessed of
other resources, has not the wherewithal to pay an income tax upon the dividend
stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital

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increase, and not income, than this demonstration that in the nature of things it requires
conversion of capital in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the

fundamental error already mentioned-a failure to appraise correctly the force of the
term 'income' as used in the Sixteenth Amendment, or at least to give practical effect
to it. Thus the government contends that the tax 'is levied on income derived from
corporate earnings,' when in truth the stockholder has 'derived' nothing except paper
certificates which, so far as they have any effect, deny him present participation in
such earnings. It contends that the tax may be laid when earnings 'are received by the
stockholder,' whereas he has received none; that the profits are 'distributed by means
of a stock dividend,' although a stock dividend distributes no profits; that under the act
of 1916 'the tax is on the stockholder's share in corporate earnings,' when in truth a
stockholder has no such share, and receives none in a stock dividend; that 'the profits
are segregated from his former capital, and he has a separate certificate representing
his invested profits or gains,' whereas there has been no segregation of profits, nor has
he any separate certificate representing a personal gain, since the certificates, new
and old, are alike in what they represent-a capital interest in the entire concerns of the
corporation.

We have no doubt of the power or duty of a court to look through the form of the
corporation and determine the question of the stockholder's right, in order to ascertain
whether he has received income taxable by Congress without apportionment. But,
looking through the form, [252 U.S. 189, 214] we cannot disregard the essential truth
disclosed, ignore the substantial difference between corporation and stockholder, treat
the entire organization as unreal, look upon stockholders as partners, when they are not
such, treat them as having in equity a right to a partition of the corporate assets, when
they have none, and indulge the fiction that they have received and realized a share
of the profits of the company which in truth they have neither received nor realized. We
must treat the corporation as a substantial entity separate from the stockholder, not
only because such is the practical fact but because it is only by recognizing such
separateness that any dividend-even one paid in money or property-can be regarded
as income of the stockholder. Did we regard corporation and stockholders as
altogether identical, there would be no income except as the corporation acquired it;
and while this would be taxable against the corporation as income under appropriate
provisions of law, the individual stockholders could not be separately and additionally
taxed with respect to their several shares even when divided, since if there were entire
identity between them and the company they could not be regarded as receiving
anything from it, any more than if one's money were to be removed from one pocket to
another.

Conceding that the mere issue of a stock dividend makes the recipient no richer than
before, the government nevertheless contends extent to which the gains accumulated
by the extend to which the gains accumulated by the corporation have made him the
richer. There are two insuperable difficulties with this: In the first place, it would depend
upon how long he had held the stock whether the stock dividend indicated the extent
to which he had been enriched by the operations of the company; unless he had held
it throughout such operations the measure would not hold true. Secondly, and more

26 | P a g e
important for present purposes, enrichment through increase in value [252 U.S. 189,
215] of capital investment is not income in any proper meaning of the term.

The complaint contains averments respecting the market prices of stock such as
plaintiff held, based upon sales before and after the stock dividend, tending to show
that the receipt of the additional shares did not substantially change the market value
of her entire holdings. This tends to show that in this instance market quotations
reflected intrinsic values-a thing they do not always do. But we regard the market prices
of the securities as an unsafe criterion in an inquiry such as the present, when the
question must be, not what will the thing sell for, but what is it in truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a case
where stockholders use money received as cash dividends to purchase additional
stock contemporaneously issued by the corporation. But an actual cash dividend, with
a real option to the stockholder either to keep the money for his own or to reinvest it in
new shares, would be as far removed as possible from a true stock dividend, such as
the one we have under consideration, where nothing of value is taken from the
company's assets and transferred to the individual ownership of the several
stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the
corporation's own shares and one made by distributing shares owned by it in the stock
of another company, calls for no comment beyond the statement that the latter
distributes assets of the company among the shareholders while the former does not,
and for no citation of authority except Peabody v. Eisner, 247 U.S. 347, 349 , 350 S., 38
Sup. Ct. 546.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of
the position of the government. [252 U.S. 189, 216] Swan Brewery Co., Ltd. v. Rex, [252
U.S. 189, 1914] A. C. 231, arose under the Dividend Duties Act of Western Australia,
which provided that 'dividend' should include 'every dividend, profit, advantage, or
gain intended to be paid or credited to or distributed among any members or directors
of any company,' except, etc. There was a stock dividend, the new shares being
allotted among the shareholders pro rata; and the question was whether this was a
distribution of a dividend within the meaning of the act. The Judicial Committee of the
Privy Council sustained the dividend duty upon the ground that, although 'in ordinary
language the new shares would not be called a dividend, nor would the allotment of
them be a distribution of a dividend,' yet, within the meaning of the act, such new
shares were an 'advantage' to the recipients. There being no constitutional restriction
upon the action of the lawmaking body, the case presented merely a question of
statutory construction, and manifestly the decision is not a precedent for the guidance
of this court when acting under a duty to test an act of Congress by the limitations of a
written Constitution having superior force.

In Tax Commissioner v. Putnam (1917) 227 Mass. 522, 116 N. E. 904, L. R. A. 1917F, 806, it
was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which
conferred upon the Legislature full power to tax incomes, 'must be interpreted as
including every item which by any reasonable understanding can fairly be regarded as

27 | P a g e
income' (227 Mass. 526, 531, 116 N. E. 904, 907 [L. R. A. 1917F, 806]), and that under it a
stock dividend was taxable as income; the court saying (227 Mass. 535, 116 N. E. 911, L.
R. A. 1917F, 806):

'In essence the thing which has been done is to distribute a symbol representing an
accumulation of profits, which instead of being paid out in cash is invested in the
business, thus augmenting its durable assets. In this aspect of the case the substance of
the transaction is no different from what it would be if a cash dividend had been
declared with the privilege of subscription to an equivalent amount of new shares.' [252
U.S. 189, 217] We cannot accept this reasoning. Evidently, in order to give a sufficiently
broad sweep to the new taxing provision, it was deemed necessary to take the symbol
for the substance, accumulation for distribution, capital accretion for its opposite; while
a case where money is paid into the hand of the stockholder with an option to buy new
shares with it, followed by acceptance of the option, was regarded as identical in
substance with a case where the stockholder receives no money and has no option.
The Massachusetts court was not under an obligation, like the one which binds us, of
applying a constitutional amendment in the light of other constitutional provisions that
stand in the way of extending it by construction.
Upon the second argument, the government, recognizing the force of the decision in
Towne v. Eisner, supra, and virtually abandoning the contention that a stock dividend
increases the interest of the stockholder or otherwise enriches him, insisted as an
alternative that by the true construction of the act of 1916 the tax is imposed, not upon
the stock dividend, but rather upon the stockholder's share of the undivided profits
previously accumulated by the corporation; the tax being levied as a matter of
convenience at the time such profits become manifest through the stock dividend. If so
construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the stock of
corporations is beyond question, and that such interests might be valued in view of the
condition of the company, including its accumulated and undivided profits, is equally
clear. But that this would be taxation of property because of ownership, and hence
would require apportionment under the provisions of the Constitution, is settled beyond
peradventure by previous decisions of this court.

The government relies upon Collector v. Hubbard (1870) [252 U.S. 189, 218] 12 Wall. 1,
(20 L. Ed. 272), which arose under section 117 of the Act of June 30, 1864 (13 Stat. 223,
282, c. 173), providing that--

'The gains and profits of all companies, whether incorporated or partnership, other than
the companies specified in that section, shall be included in estimating the annual
gains, profits, or income of any person, entitled to the same, whether divided or
otherwise.'
The court held an individual taxable upon his proportion of the earnings of a
corporation although not declared as dividends and although invested in assets not in
their nature divisible. Conceding that the stockholder for certain purposes had no title
prior to dividend declared, the court nevertheless said (12 Wall. 18):

28 | P a g e
'Grant all that, still it is true that the owner of a share of stock in a corporation holds the
share with all its incidents, and that among those incidents is the right to receive all
future dividends, that is, his proportional share of all profits not then divided. Profits are
incident to the share to which the owner at once becomes entitled provided he
remains a member of the corporation until a dividend is made. Regarded as an
incident to the shares, undivided profits are property of the shareholder, and as such
are the proper subject of sale, gift, or devise. Undivided profits invested in real estate,
machinery, or raw material for the purpose of being manufactured are investments in
which the stockholders are interested, and when such profits are actually appropriated
to the payment of the debts of the corporation they serve to increase the market value
of the shares, whether held by the original subscribers or by assignees.'
In so far as this seems to uphold the right of Congress to tax without apportionment a
stockholder's interest in accumulated earnings prior to dividend declared, it must be
regarded as overruled by Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601, 627 , 628 S.,
637, 15 Sup. Ct. 912. Conceding Collector v. Hubbard was inconsistent with the doctrine
of that case, because it sustained a direct tax upon property not apportioned [252 U.S.
189, 219] AMONG THE STATES, THE GOVERNMENT NEVERTHEless insists that the sixteenth
Amendment removed this obstacle, so that now the Hubbard Case is authority for the
power of Congress to levy a tax on the stockholder's share in the accumulated profits of
the corporation even before division by the declaration of a dividend of any kind.
Manifestly this argument must be rejected, since the amendment applies to income
only, and what is called the stockholder's share in the accumulated profits of the
company is capital, not income. As we have pointed out, a stockholder has no
individual share in accumulated profits, nor in any particular part of the assets of the
corporation, prior to dividend declared.

Thus, from every point of view we are brought irresistibly to the conclusion that neither
under the Sixteenth Amendment nor otherwise has Congress power to tax without
apportionment a true stock dividend made lawfully and in good faith, or the
accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916,
in so far as it imposes a tax upon the stockholder because of such dividend,
contravenes the provisions of article 1, 2, cl. 3, and article 1, 9, cl. 4, of the Constitution,
and to this extent is invalid, notwithstanding the Sixteenth Amendment.

Judgment affirmed.

Mr. Justice HOLMES, dissenting.

I think that Towne v. Eisner, 245 U.S. 418 , 38 Sup. Ct. 158, L. R. A. 1918D, 254, was right in
its reasoning and result and that on sound principles the stock dividend was not
income. But it was clearly intimated in that case that the construction of the statute
then before the Court might be different from that of the Constitution. 245 U.S. 425 , 38
Sup. Ct. 158, L. R. A. 1918D, 254. I think that the word 'incomes' in the Sixteenth
Amendment should be read in [252 U.S. 189, 220] 'a sense most obvious to the
common understanding at the time of its adoption.' Bishop v. State, 149 Ind. 223, 230, 48
N. E. 1038, 1040, 39 L. R. A. 278, 63 Am. St. Rep. 270; State v. Butler, 70 Fla. 102, 133, 69
South. 771. For it was for public adoption that it was proposed. McCulloch v. Maryland,
4 Wheat. 316, 407. The known purpose of this Amendment was to get rid of nice

29 | P a g e
questions as to what might be direct taxes, and I cannot doubt that most people not
lawyers would suppose when they voted for it that they put a question like the present
to rest. I am of opinion that the Amendment justifies the tax. See Tax Commissioner v.
Putnam, 227 Mass. 522, 532, 533, 116 N. E. 904, L. R. A. 1917F, 806.

Mr. Justice DAY concurs in this opinion.

Mr. Justice BRANDEIS delivered the following [dissenting] opinion:

Financiers, with the aid of lawyers, devised long ago two different methods by which a
corporation can, without increasing its indebtedness, keep for corporate purposes
accumulated profits, and yet, in effect, distribute these profits among its stockholders.
One method is a simple one. The capital stock is increased; the new stock is paid up
with the accumulated profits; and the new shares of paid-up stock are then distributed
among the stockholders pro rata as a dividend. If the stockholder prefers ready money
to increasing his holding of the stock in the company, he sells the new stock received as
a dividend. The other method is slightly more complicated. .arrangements are made for
an increase of stock to be offered to stockholders pro rata at par, and, at the same
time, for the payment of a cash dividend equal to the amount which the stockholder
will be required to pay to [252 U.S. 189, 221] the company, if he avails himself of the
right to subscribe for his pro rata of the new stock. If the stockholder takes the new
stock, as is expected, he may endorse the dividend check received to the corporation
and thus pay for the new stock. In order to ensure that all the new stock so offered will
be taken, the price at which it is offered is fixed far below what it is believed will be its
market value. If the stockholder prefers ready money to an increase of his holdings of
stock, he may sell his right to take new stock pro rata, which is evidenced by an
assignable instrument. In that event the purchaser of the rights repays to the
corporation, as the subscription price of the new stock, an amount equal to that which
it had paid as a chsh dividend to the stockholder.

Both of these methods of retaining accumulated profits while in effect distributing them
as a dividend had been in common use in the United States for many years prior to the
adoption of the Sixteenth Amendment. They were recognized equivalents. Whether a
particular corporation employed one or the other method was determined sometimes
by requirements of the law under which the corporation was organized; sometimes it
was determined by preferences of the individual officials of the corporation; and
sometimes by stock market conditions. Whichever method was employed the resultant
distribution of the new stock was commonly referred to as a stock dividend. How these
two methods have been employed may be illustrated by the action in this respect (as
reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial
Chronicle) of some of the Standard Oil companies, since the disintegration pursuant to
the decision of this court in 1911. Standard Oil Co. v. United States, 221 U.S. 1 , 31 Sup.
Ct. 502, 34 L. R. A. (N. S.) 834, Ann. Cas. 1912D, 734.

(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911,
$1,000,000 capital stock (all common), and a large surplus. On May 15, [252 U.S. 189,
222] 1912, it increased its capital stock to $30,000,000, and paid a simple stock
dividend of 2,900 per cent. in stock. 2

30 | P a g e
(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31,
1911, $600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it
paid a simple stock dividend of 33 1/3 per cent., increasing the outstanding capital to
$800,000. During the calendar year 1912 it paid cash dividends aggregating 20 per
cent., but it earned considerably more, and had at the close of the year again a
substantial surplus. On June 20, 1913, it declared a further stock dividend of 25 per
cent., thus increasing the capital to $1,000,000.3

(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December
31, 1913, $1,000,000 capital stock (all common) and $3,701, 710 surplus. Of this surplus
$902,457 had been earned during the calendar year 1913, the net profits of that year
having been $1,002,457 and the dividends paid only $100,000 (10 per cent.). On
December 22, 1913, a cash dividend of $200 per share was declared payable on
February 14, 1914, to stockholders of record January 31, 1914, and these stockholders
were offered the right to subscribe for an equal amount of new stock at par and to
apply the cash dividend in payment therefor. The outstanding stock was thus increased
to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends were
paid on this stock at an annual rate of between 15 per cent. and 20 per cent., but the
company's surplus increased by $2,347,614, so that on December 31, 1916, it had a
large surplus over its $3,000,000 capital stock. On December 15, 1916, the company
issued a circular to the stockholders, saying:

'The company's business for this year has shown a [252 U.S. 189, 223] very good
increase in volume and a proportionate increase in profits, and it is estimated that by
January 1, 1917, the company will have a surplus of over $4,000,000. The board feels
justified in stating that if the proposition to increase the capital stock is acted on
favorably, it will be proper in the near future to declare a cash dividend of 100 per cent.
and to allow the stockholders the privilege pro rata according to their holdings, to
purchase the new stock at par, the plan being to allow the stockholders, if they desire,
to use their cash dividend to pay for the new stock.'
The increase of stock was voted. The company then paid a cash dividend of 100 per
cent., payable May 1, 1917, again offering to such stockholders the right to subscribe
for an equal amount of new stock at par and to apply the cash dividend in payment
therefor.

Moody's Manual, describing the transaction with exactness, says first that the stock was
increased from $3,000,000 to $6,000,000, 'a cash dividend of 100 per cent., payable
May 1, 1917, being exchanged for one share of new stock, the equivalent of a 100 per
cent. stock dividend.' But later in the report giving, as customary in the Manual the
dividend record of the company, the Manual says: 'A stock dividend of 200 per cent.
was paid February 14, 1914, and one of 100 per cent. on May 1, 1197.' And in reporting
specifically the income account of the company for a series of years ending December
31, covering net profits, dividends paid and surplus for the year, it gives, as the
aggregate of dividends for the year 1917, $ 660,000 (which was the aggregate paid on
the quarterly cash dividend-5 per cent. January and April; 6 per cent. July and
October), and adds in a note: 'In addition a stock dividend of 100 per cent. was paid
during the year.' 4 The Wall Street Journal of [252 U.S. 189, 224] May 2, 1917, p. 2,
quotes the 1917 'high' price for Standard Oil of Kentucky as '375 ex stock dividend.'

31 | P a g e
It thus appears that among financiers and investors the distribution of the stock, by
whichever method effected, is called a stock dividend; that the two methods by which
accumulated profits are legally retained for corporate purposes and at the same time
distributed as dividends are recognized by them to be equivalents; and that the
financial results to the corporation and to the stockholders of the two methods are
substantially the same-unless a difference results from the application of the federal
Income Tax Law.

Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder
in the Standard Oil Company (of California), a corporation organized under the laws of
California and having its principal place of business in that state. During that year she
received from the company a stock dividend representing profits earned since March
1, 1913. The dividend was paid by direct issue of the stock to her according to the
simple method described above, pursued also by the Indiana and Nebraska
companies. In 1917 she was taxed under the federal law on the stock dividend so
received at its par value of $100 a share, as income received during the year 1916.
Such a stock dividend is income, as distinguished from capital, both under the law of
New York and under the law of California, because in both states every dividend
representing profits is deemed to be income, whether paid in cash or in stock. It had
been so held in New York, where the question arose as between life tenant and
remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N. Y. 137, 64 N. E. 796; Matter of
Osborne, 209 N. Y. 450, 103 N. E. 723, 823, 50 L. R. A. ( N. S.) 510, Ann.Cas. 1915A, 298;
and also, where the question arose in matters of taxation, People v. Glynn, [252 U.S. 189,
225] 130 App. Div. 332, 114 N. Y. Supp. 460; Id. 198 N. Y. 605, 92 N. E. 1097. It has been
so held in California, where the question appears to have arisen only in controversies
between life tenant and remainderman. Estate of Duffill, 183 Pac. 337.

It is conceded that if the stock dividend paid to Mrs. Macomber had been made by
the more complicated method pursued by the Standard Oil Company of Kentucky;
that is, issuing rights to take new stock pro rata and paying to each stockholder
simultaneously a dividend in cash sufficient in amount to enable him to pay for this pro
rata of new stock to be purchased-the dividend so paid to him would have been
taxable as income, whether he retained the cash or whether he returned it to the
corporation in payment for his pro rata of new stock. But it is contended that, because
the simple method was adopted of having the new stock issued direct to the
stockholders as paid-up stock, the new stock is not to be deemed income, whether she
retained it or converted it into cash by sale. If such a different result can flow merely
from the difference in the method pursued, it must be because Congress is without
power to tax as income of the stockholder either the stock received under the latter
method or the proceeds of its sale; for Congress has, by the provisions in the Revenue
Act of 1916, expressly declared its purpose to make stock dividends, by whichever
method paid, taxable as income.

The Sixteenth Amendment, proclaimed February 25, 1913, declares:

'The Congress shall have power to lay and collect taxes on incomes, from whatever
source derived, without apportionment among the several states, and without regard
to any census or enumeration.'

32 | P a g e
The Revenue Act of September 8, 1916, c. 463, 2a, 39 Stat. 756, 757, provided:

'That the term 'dividends' as used in this title shall [252 U.S. 189, 226] be held to mean
any distribution made or ordered to be made by a corporation, ... out of its earnings or
profits accrued since March first, nineteen hundred and thirteen, and payable to its
shareholders, whether in cash or in stock of the corporation, ... which stock dividend
shall be considered income, to the amount of its cash value.'
Hitherto powers conferred upon Congress by the Constitution have been liberally
construed, and have been held to extend to every means appropriate to attain the
end sought. In determining the scope of the power the substance of the transaction,
not its form has been regarded. Martin v. Hunter, 1 Wheat, 304, 326; McCulloch v.
Maryland, 4 Wheat. 316, 407, 415; Brown v. Maryland, 12 Wheat. 419, 446; Craig v.
Missouri, 4 Pet. 410, 433; Jarrolt v. Moberly, 103 U.S. 580, 585 , 587 S.; Legal Tender
Case,110 U.S. 421, 444 , 4 S. Sup. Ct. 122; Lithograph Co. v. Sarony, 111 U.S. 53, 58 , 4 S.
Sup. Ct. 279; United States v. Realty Co., 163 U.S. 427, 440 , 441 S., 442, 16 Sup. Ct. 1120;
South Carolina v. United States,199 U.S. 437, 448 , 449 S., 26 Sup. Ct. 110, 4 Ann. Cas. 737.
Is there anything in the phraseology of the Sixteenth Amendment or in the nature of
corporate dividends which should lead to a departure from these rules of construction
and compel this court to hold, that Congress is powerless to prevent a result so
extraordinary as that here contended for by the stockholder?

First. The term 'income,' when applied to the investment of the stockholder in a
corporation, had, before the adoption of the Sixteenth Amendment, been commonly
understood to mean the returns from time to time received by the stockholder from
gains or earnings of the corporation. A dividend received by a stockholder from a
corporation may be either in distribution of capital assets or in distribution of profits.
Whether it is the one or the other is in no way affected by the medium in which it is
paid, nor by the method or means through which the particular thing distributed as a
dividend was procured. If the [252 U.S. 189, 227] dividend is declared payable in cash,
the money with which to pay it is ordinarily taken from surplus cash in the treasury. But (if
there are profits legally available for distribution and the law under which the company
was incorporated so permits) the company may raise the money by discounting
negotiable paper; or by selling bonds, scrip or stock of another corporation then in the
treasury; or by selling its own bonds, scrip or stock then in the treasury; or by selling its
own bonds, scrip or stock issued expressly for that purpose. How the money shall be
raised is wholly a matter of financial management. The manner in which it is raised in no
way affects the question whether the dividend received by the stockholder is income
or capital; nor can it conceivably affect the question whether it is taxable as income.

Likewise whether a dividend declared payable from profits shall be paid in cash or in
some other medium is also wholly a matter of financial management. If some other
medium is decided upon, it is also wholly a question of financial management whether
the distribution shall be, for instance, in bonds, scrip or stock of another corporation or in
issues of its own. And if the dividend is paid in its own issues, why should there be a
difference in result dependent upon whether the distribution was made from such
securities then in the treasury or from others to be created and issued by the company
expressly for that purpose? So far as the distribution may be made from its own issues of
bonds, or preferred stock created expressly for the purpose, it clearly would make no

33 | P a g e
difference in the decision of the question whether the dividend was a distribution of
profits, that the securities had to be created expressly for the purpose of distribution. If a
dividend paid in securities of that nature represents a distribution of profits Congress
may, of course, tax it as income of the stockholder. Is the result different where the
security distributed is common stock? [252 U.S. 189, 228] Suppose that a corporation
having power to buy and sell its own stock, purchases, in the interval between its
regular dividend dates, with moneys derived from current profits, some of its own
common stock as a temporary investment, intending at the time of purchase to sell it
before the next dividend date and to use the proceeds in paying dividends, but later,
deeming it inadvisable either to sell this stock or to raise by borrowing the money
necessary to pay the regular dividend in cash, declares a dividend payable in this
stock; can any one doubt that in such a case the dividend in common stock would be
income of the stockholder and constitutionally taxable as such? See Green v. Bissell, 79
Conn. 547, 65 Atl. 1056, 8 L. R. A. (N. S.) 1011, 118 Am. St. Rep. 156, 9 Ann. Cas. 287;
Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of the
stockholder subject to taxation if the purpose of the company in buying the stock so
distributed had been from the beginning to take it off the market and distribute it
among the stockholders as a dividend, and the company actually did so? And
proceeding a short step further: Suppose that a corporation decided to capitalize
some of its accumulated profits by creating additional common stock and selling the
same to raise working capital, but after the stock has been issued and certificates
therefor are delivered to the bankers for sale, general financial conditions make it
undesirable to market the stock and the company concludes that it is wiser to husband,
for working capital, the cash which it had intended to use in paying stockholders a
dividend, and, instead, to pay the dividend in the common stock which it had planned
to sell; would not the stock so distributed be a distribution of profits-and hence, when
received, be income of the stockholder and taxable as such? If this be conceded, why
should it not be equally income of the stockholder, and taxable as such, if the common
stock created by capitalizing profits, had been originally created for the express
purpose of being distributed [252 U.S. 189, 229] as a dividend to the stockholder who
afterwards received it?

Second. It has been said that a dividend payable in bonds or preferred stock created
for the purpose of distributing profits may be income and taxable as such, but that the
case is different where the distribution is in common stock created for that purpose.
Various reasons are assigned for making this distinction. One is that the proportion of the
stockholder's ownership to the aggregate number of the shares of the company is not
changed by the distribution. But that is equally true where the dividend is paid in its
bonds or in its preferred stock. Furthermore, neither maintenance nor change in the
proportionate ownership of a stockholder in a corporation has any bearing upon the
question here involved. Another reason assigned is that the value of the old stock held
is reduced approximately by the value of the new stock received, so that the
stockholder after receipt of the stock dividend has no more than he had before it was
paid. That is equally true whether the dividend be paid in cash or in other property, for
instance, bonds, scrip or preferred stock of the company. The payment from profits of a
large cash dividend, and even a small one, customarily lowers the then market value of
stock because the undivided property represented by each share has been
correspondingly reduced. The argument which appears to be most strongly urged for

34 | P a g e
the stockholders is, that when a stock dividend is made, no portion of the assets of the
company is thereby segregated for the stockholder. But does the issue of new bonds or
of preferred stock created for use as a dividend result in any segregation of assets for
the stockholder? In each case he receives a piece of paper which entitles him to
certain rights in the undivided property. Clearly segregation of assets in a physical sense
is not an essential of income. The year's gains of a partner is taxable as income,
although there, likewise, no [252 U.S. 189, 230] segregation of his share in the gains from
that of his partners is had.

The objection that there has been no segregation is presented also in another form. It is
argued that until there is a segregation, the stockholder cannot know whether he has
really received gains; since the gains may be invested in plant or merchandise or other
property and perhaps be later lost. But is not this equally true of the share of a partner in
the year's profits of the firm or, indeed, of the profits of the individual who is engaged in
business alone? And is it not true, also, when dividends are paid in cash? The gains of a
business, whether conducted by an individual, by a firm or by a corporation, are
ordinarily reinvested in large part. Many a cash dividend honestly declared as a
distribution of profits, proves later to have been paid out of capital, because errors in
forecast prevent correct ascertainment of values. Until a business adventure has been
completely liquidated, it can never be determined with certainty whether there have
been profits unless the returns at least exceeded the capital originally invested. Business
men, dealing with the problem practically, fix necessarily periods and rules for
determining whether there have been net profits-that is, income or gains. They protect
themselves from being seriously misled by adopting a system of depreciation charges
and reserves. Then, they act upon their own determination, whether profits have been
made. Congress in legislating has wisely adopted their practices as its own rules of
action.

Third. The Government urges that it would have been within the power of Congress to
have taxed as income of the stockholder his pro rata share of undistributed profits
earned, even if no stock dividend representing it had been paid. Strong reasons may
be assigned for such a view. See The Collector v. Hubbard, 12 Wall. 1. The undivided
share of a partner in the year's undistributed profits of his firm [252 U.S. 189, 231] is
taxable as income of the partner, although the share in the gain is not evidenced by
any action taken by the firm. Why may not the stockholder's interest in the gains of the
company? The law finds no difficulty in disregarding the corporate fiction whenever
that is deemed necessary to attain a just result. Linn Timber Co. v. United States, 236 U.S.
574 , 35 Sup. Ct. 440. See Morawetz on Corporations (2d Ed.) 227- 231; Cook on
Corporations (7th Ed.) 663, 664. The stockholder's interest in the property of the
corporation differs, not fundamentally but in form only, from the interest of a partner in
the property of the firm. There is much authority for the proposition that, under our law,
a partnership or joint stock company is just as distinct and palpable an entity in the idea
of the law, as distinguished from the individuals composing it, as is a corporations. 5 No
reason appears, why Congress, in legislating under a grant of power so comprehensive
as that authorizing the levy of an income tax, should be limited by the particular view of
the relation of the stockholder to the corporation and its property which may, in the
absence of legislation, have been taken by this court. But we have no occasion to
decide the question whether Congress might have taxed to the stockholder his

35 | P a g e
undivided share of the corporation's earnings. For Congress has in this act limited the
income tax to that share of the stockholder in the earnings which is, in effect, distributed
by means of the stock dividend paid. In other words to render the stockholder taxable
there must be both earnings made and a dividend paid. Neither earnings without
dividend-nor a dividend without earnings-subjects the [252 U.S. 189, 232] stockholder
to taxation under the Revenue Act of 1916.

Fourth. The equivalency of all dividends representing profits, whether paid of all
dividends in stock, is so complete that serious question of the taxability of stock
dividends would probably never have been made, if Congress had undertaken to tax
only those dividends which represented profits earned during the year in which the
dividend was paid or in the year preceding. But this court, construing liberally, not only
the constitutional grant of power, but also the revenue act of 1913, held that Congress
might tax, and had taxed, to the stockholder dividends received during the year,
although earned by the company long before; and even prior to the adoption of the
Sixteenth Amendment. Lynch v. Hornby,247 U.S. 339 , 38 Sup. Ct. 543.6 That rule, if
indiscriminatingly applied to all stock dividends representing profits earned, might, in
view of corporate practice, have worked considerable hardship, and have raised
serious questions. Many corporations, without legally capitalizing any part of their profits,
had assigned definitely some part or all of the annual balances remaining after paying
the usual cash dividends, to the uses to which permanent capital is ordinarily applied.
Some of the corporations doing this, transferred such balances on their books to 'surplus'
account-distinguishing between such permanent 'surplus' and the 'undivided profits'
account. Other corporations, without this formality, had assumed that the annual
accumulating balances carried as undistributed profits were to be treated as capital
permanently invested in the business. And still others, without definite assumption of any
kind, had [252 U.S. 189, 233] so used undivided profits for capital purposes. To have
made the revenue law apply retroactively so as to reach such accumulated profits, if
and whenever it should be deemed desirable to capitalize them legally by the issue of
additional stock distributed as a dividend to stockholders, would have worked great
injustice. Congress endeavored in the Revenue Act of 1916 to guard against any serious
hardship which might otherwise have arisen from making taxable stock dividends
representing accumulated profits. It did not limit the taxability to stock dividends
representing profits earned within the tax year or in the year preceding; but it did limit
taxability to such dividends representing profits earned since March 1, 1913. Thereby
stockholders were given notice that their share also in undistributed profits
accumulating thereafter was at some time to be taxed as income. And Congress
sought by section 3 (Comp. St. 1918, Comp. St. Ann. Supp. 1919, 6336c) to discourage
the postponement of distribution for the illegitimate purpose of evading liability to
surtaxes.

Fifth. The decision of this court, that earnings made before the adoption of the Sixteenth
Amendment, but paid out in cash dividend after its adoption, were taxable as income
of the stockholder, involved a very liberal construction of the amendment. To hold now
that earnings both made and paid out after the adoption of the Sixteenth Amendment
cannot be taxed as income of the stockholder, if paid in the form of a stock dividend,
involves an exceedingly narrow construction of it. As said by Mr. Chief Justice Marshall
in Brown v. Maryland, 12 Wheat. 419, 446 (6 L. Ed. 678):

36 | P a g e
'To construe the power so as to impair its efficacy, would tend to defeat an object, in
the attainment of which the American public took, and justly took, that strong interest
which arose from a full conviction of its necessity.'
No decision heretofore rendered by this court requires us to hold that Congress, in
providing for the taxation of [252 U.S. 189, 234] stock dividends, exceeded the power
conferred upon it by the Sixteenth Amendment. The two cases mainly relied upon to
show that this was beyond the power of Congress are Towne v. Eisner, 245 U.S. 418 , 38
Sup. Ct. 158 L. R. A. 1918D, 254, which involved a question not of constitutional power
but of statutory construction, and Gibbons v. Mahon, 136 U.S. 549 , 10 Sup. Ct. 1057,
which involved a question arising between life tenant and remainderman. So far as
concerns Towne v. Eisner we have only to bear in mind what was there said ( 245 U.S.
425 , 38 Sup. Ct. 159, L. R. A. 1918D, 254): 'But it is not necessarily true that income means
the same thing in the Constitution and the [an] act.' 7 Gibbons v. Mahon is even less an
authority for a narrow construction of the power to tax incomes conferred by the
Sixteenth Amendment. In that case the court was required to determine how, in the
administration of an estate in the District of Columbia, a stock dividend, representing
profits, received after the decedent's death, should be disposed of as between life
tenant and remainderman. The question was in essence: What shall the intention of the
testator be presumed to have been? On this question there was great diversity of
opinion and practice in the courts of English-speaking countries. Three well-defined rules
were then competing for acceptance; two of these involves an arbitrary rule of
distribution, the third equitable apportionment. See Cook on Corporations ( 7th Ed.)
552-558.

1. The so-called English rule, declared in 1799, by Brander v. Brander, 4 Ves. Jr. 800, that
a dividend representing [252 U.S. 189, 235] profits, whether in cash, stock or other
property, belongs to the life tenant if it was a regular or ordinary dividend, and belongs
to the remainderman if it was an extraordinary dividend.

2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, 96
Am. Dec. 705, that a dividend representing profits, whether regular, ordinary or
extrordinary, if in cash belongs to the life tenant, and if in stock belongs to the
remainderman.

3. The so-called Pennsylvania rule declared in 1857 by Earp's Appeal, 28 Pa. 368, that
where a stock dividend is paid, the court shall inquire into the circumstances under
which the fund had been earned and accumulated out of which the dividend,
whether a regular, an ordinary or an extraordinary one, was paid. If it finds that the
stock dividend was paid out of profits earned since the decedent's death, the stock
dividend belongs to the life tenant; if the court finds that the stock dividend was paid
from capital or from profits earned before the decedent's death, the stock dividend
belongs to the remainderman.

This court adopted in Gibbons v. Mahon as the rule of administration for the District of
Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr.
Justice Gray. Since then the same question has come up for decision in many of the
states. The so-called Massachusetts rule, although approved by this court, has found
favor in only a few states. The so-called Pennsylvania rule, on the other hand, has been

37 | P a g e
adopted since by so many of the states (including New York and California), that it has
come to be known as the 'American rule.' Whether, in view of these facts and the
practical results of the operation of the two rules as shown by the experience of the 30
years which have elapsed since the decision in Gibbons v. Mahon, it might be desirable
for this court to reconsider the question there decided, as [252 U.S. 189, 236] some
other courts have done (see 29 Harvard Law Review, 551), we have no occasion to
consider in this case. For, as this court there pointed out ( 136 U.S. 560 , 1059 [34 L. Ed.
525]), the question involved was one 'between the owners of successive interests in
particular shares,' and not, as in Bailey v. Railroad Co., 22 Wall. 604, a question 'between
the corporation and the government, and [which] depended upon the terms of a
statute carefully framed to prevent corporations from evading payment of the tax
upon their earnings.'

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

'Had the company distributed the 101,450 among the shareholders and had the
shareholders repaid such sums to the company as the price of the 81,160 new SHARES,
THE DUTY ON THE 101,450 [252 U.S. 189, 237] WOULD CLEARLY HAVE BEEN PAYable. is
not this virtually the effect of what was actually done? I think it is.'
Sixth. If stock dividends representing profits are held exempt from taxation under the
Sixteenth Amendment, the owners of the most successful businesses in America will, as
the facts in this case illustrate, be able to escape taxation on a large part of what is
actually their income. So far as their profits are represented by stock received as
dividends they will pay these taxes not upon their income but only upon the income of
their income. That such a result was intended by the people of the United States when
adopting the Sixteenth Amendment is inconceivable. Our sole duty is to ascertain their
intent as therein expressed. 8 In terse, comprehensive language befitting the
Constitution, they empowered Congress 'to lay and collect taxes on incomes from
whatever source derived.' They intended to include thereby everything which by
reasonable understanding can fairly be regarded as income. That stock dividends
representing profits are so regarded, not only by the plain people, but by investors and
financiers, and by most of the courts of the country, is shown, beyond peradventure, by
their acts and by their utterances. It seems to me clear, therefore, that Congress

38 | P a g e
possesses the power which it exercised to make dividends representing profits, taxable
as income, whether the medium in which the dividend is paid be cash or stock, and
that it may define, as it has done, what dividends representing [252 U.S. 189,
238] profits shall be deemed income. It surely is not clear that the enactment exceeds
the power granted by the Sixteenth Amendment. And, as this court has so often said,
the high prerogative of declaring an act of Congress invalid, should never be exercised
except in a clear case. 9

'It is but a decent respect due to the wisdom, the integrity and the patriotism of the
legislative body, by which any law is passed, to presume in favor of its validity, until its
violation of the Constitution is proved beyond all reasonable doubt.' Ogden v.
Saunders, 12 Wheat. 213, 269.
Mr. Justice CLARKE concurs in this opinion.

Footnotes
[ Footnote 1 ] Title I.-Income Tax.

Part I.-On Individuals.

Sec. 2. (a) That, subject only to such exemptions and deductions as are hereinafter
allowed, the net income of a taxable person shall include gains, profits, and income
derived, ... also from interest, rent, dividends, securities, or the transaction of any
business carried on for gain or profit, or gains or profits and income derived from any
source whatever: Provided, that the term 'dividends' as used in this title shall be held to
mean any distribution made or ordered to be made by a corporation, ... out of its
earnings or profits accrued since March first, nineteen hundred and thirteen, and
payable to its shareholders, whether in cash or in stock of the corporation, ... which
stock dividend shall be considered income, to the amount of its cash value.

[ Footnote 2 ] Moody's p. 1544; Commercial and Financial Chronicle, vol. 94, p. 831; vol.
98, pp. 1005, 1076.

[ Footnote 3 ] Moody's, p. 1548; Commercial and Financial Chronicle, vol. 94, p. 771; vol.
96, p. 1428; vol. 97, p. 1434; vol. 98, p. 1541.

[ Footnote 4 ] Moody's, p. 1547; Commercial and Financial Chronicle, vol. 97, pp. 1589,
1827, 1903; vol. 98, pp. 76, 457; vol. 103, p. 2348. Poor's Manual of Industrials (1918), p.
2240, in giving the 'comparative income account' of the company, describes the 1914
dividend as 'stock dividend paid (200 per cent.)-$2,000,000,' and describes the 1917
dividend as $3,000,000 special cash dividend.'

[ Footnote 5 ] See Some Judicial Myths, by Francis M. Burdick, 22 Harvard Law Review,
393, 394-396; The Firm as a Legal Person, by William Hamilton Cowles, 57 Cent. L. J., 343,
348; The Separate Estates of Non-Bankrupt Partners, by J. D. Brannan, 20 Harvard Law
Review, 589-592. Compare Harvard Law Review, vol. 7, p. 426; vol. 14, p. 222; vol. 17, p.
194.

[ Footnote 6 ] The hardship supposed to have resulted from such a decision has been
removed in the Revenue Act of 1916 as amended, by providing in section 31b (Comp.

39 | P a g e
St. 1918, Comp. St. Ann. Supp. 1919, 6336z) that such cash dividends shall thereafter be
exempt from taxation, if before they are made all earnings made since February 28,
1913, shall have been distributed. Act Oct. 3, 1917, c. 63, 1211, 40 Stat. 338, Act Feb. 24,
1919, c. 18, 201(b), 40 Stat. 1059 (Comp. St. Ann. Supp. 1919, 6336 1/8b).

[ Footnote 7 ] Compare Rugg, C. J., in Tax Commissioner v. Putnam, 227 Mass. 522, 533,
116 N. E. 904, 910 (L. R. A. 1917F, 806): 'However strong such an argument might be
when urged as to the interpretation of a statute, it is not of prevailing force as to the
broad considerations involved in the interpretation of an amendment to the
Constitution adopted under the conditions preceding and attendant upon the
ratification of the forty- fourth amendment.'

[ Footnote 8 ] Compare Rugg, C. J., Tax Commissioner v. Putnam, 227 Mass. 522, 524,
116 N. E. 904, 910 (L. R. A. 1917F, 806): 'It is a grant from the sovereign people and not
the exercise of a delegated power. It is a statement of general principles and not a
specification of details. Amendments to such a charter of government ought to be
construed in the same spirit and according to the same rules as the original. It is to be
interpreted as the Constitution of a state and not as a statute or an ordinary piece of
legislation. Its words must be given a construction adapted to carry into effect its
purpose.'

[ Footnote 9 ] 'It is our duty, when required in the regular course of judicial proceedings,
to declare an act of Congress void if not within the legislative power of the United
States; but this declaration should never be made except in a clear case. Every
possible presumption is in favor of the validity of a statute, and this continues until the
contrary is shown beyond a rational doubt. One branch of the government cannot
encroach on the domain of another without danger. The safety of our institutions
depends in no small degree on a strict observance of this salutary rule.' The 'Sinking
Fund Cases, 99 U.S. 700 , 718 (1878). See also Legal Tender Cases, 12 Wall. 457, 531
(1870); Trade Mark Cases, 100 U.S. 82 , 96 (1879). See American Doctrine of
Constitutional Law by James B. Thayer, 7 Harvard Law Review, 129, 142.

'With the exception of the extraordinary decree rendered in the Dred Scott Case, ... all
of the acts or the portions of the acts of Congress invalidated by the courts before 1868
related to the organization of courts. Denying the power of Congress to make notes
legal tender seems to be the first departure from this rule.' Haines, American Doctrine of
Judicial Supremacy, p. 288. The first legal tender decision was overruled in part two
years later (1870), Legal Tender Cases, 12 Wall. 457; and again in 1883, Legal Tender
Case, 110 U.S. 421 , 4 Sup. Ct. 122.

40 | P a g e
 Republic of the Philippines
SUPREME COURT
Manila

EN BANC

G.R. No. L-21186 February 27, 1924

FREDERICK C. FISHER, plaintiff-appellee,

vs.
WENCESLAO TRINIDAD, Collector of International Revenue, defendant-appellant.

Attorney-General Villa-Real for appellant.

Fisher DeWitt, Perkins and Brady and Johns R. McFie, Jr., for appellee.

STATEMENT

October 19, 1920, the plaintiff, a resident of the City of Manila, filed a complaint against
the defendant as Collector of Internal Revenue, in which he alleged that he was a
shareholder in the Philippine-American Drug Company, a domestic corporation; that in
the year 1919, he received from the drug company certificates of shares of the par
value of P24,800, as his proportionate share of a stock dividend, duly and lawfully
declared by the company; that the defendant erroneously and unlawfully, and against
the will and protest of the plaintiff, required him to pay an income tax on such stock
dividend in the amount of P899.91; that plaintiff paid the tax under protest, and made a
written demand upon the defendant for its return, which was refused, and plaintiff
prays for judgment for the amount, with interest and costs.

A demurrer was filed to the complaint upon the ground that it "does not state facts
sufficient to constitute a cause of action," which was sustained by the trial court, and
the plaintiff, refusing to plead further, the complaint was dismissed. From which ruling
the plaintiff appealed to this court where the decision of the lower court was reversed
by this court,1 and the case was remanded to the lower court for further proceedings
not inconsistent with the opinion.

The defendant filed an answer, denying all of the material allegations of the complaint,
and as a further and special defense, alleged that the stock dividend in question
"represented and was declared and paid out of the earnings and profits earned by
and accrued to the said Philippine-American Drug Company since March 1, 1913, and
distributed by said corporation among its stockholders;" that the par value of the stock
"did not exceed the amount of the earnings and profits actually earned by the
corporation;" and that by reason thereof the defendant levied the tax in question,
which was paid under protest.

The case was tried and submitted upon an agreed statement of facts, and the court
rendered judgment in favor of the plaintiff for the amount of P899.91, without interest
and costs, from which decision the defendant appeals, contending:

41 | P a g e
 I. The court below erred in holding that the Philippine Legislature had no power
to tax a stock dividend as income in an income tax law.

II. The court below erred in not passing on the constitutional question raised.

III. The court below erred in rendering judgment for the plaintiff.

JOHNS, J.:

December 14, 1923, after the appeal was perfected, the plaintiff wrote the defendant
a letter in which he said:

Please be advised that I hereby withdraw the protest heretofore made by me on

the 30th day of March, 1920, in connection with income tax in the amount of
P899.91 assessed by you on shares of the Philippine-American Drug Company of
the par value of P24,800.

This was later confirmed by another letter addressed to this court stating in substance
that the plaintiff had withdrawn and did not rely upon his protest because he had since
sold the stock in question. Notwithstanding that fact, the Attorney-General insists upon
a decision by this court on the merits, and in particular as to the constitutionality of the
law and the legal right of the defendant to levy and collect the tax in question.

The plaintiff contends that the record now presents a moot case, and for such there is
nothing left for this court to decide. That contention must be sustained. The payment of
the money under protest was the basis of plaintiff's action, without which it could not be
sustained. His protest is now withdrawn. The legal effect of it is to withdraw his complaint
and to place the whole matter in the same position as if no protest had ever been
made. It must be conceded that in the absence of a protest the action could not be
maintained. In other words, the plaintiff is now in court seeking to recover money which
was not paid under protest. It is true that the plaintiff obtained judgment against the
defendant in the lower court, but in legal effect the withdrawal of the protest was a
waiver of all of plaintiff's rights under that judgment. For such reason, there is nothing left
for this court to decide.

Without passing upon the merits of the question involved or the constitutionality of the
act or the right of the defendant to levy the tax in question, the judgment of the lower
court is reversed, and plaintiff's complaint is dismissed, with judgment for costs in both
this and the lower court against the plaintiff and in favor of the defendant. So ordered.

Araullo, C.J., Johnson, Street, Malcolm, Avancea, Ostrand and Romualdez, JJ.,
concur.

42 | P a g e
 SECOND DIVISION

[G.R. No. 149636. June 8, 2005]

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. BANK OF

COMMERCE, respondent.

DECISION
CALLEJO, SR., J.:

This is a petition for review on certiorari of the Decision[1] of the Court of Appeals
(CA) in CA-G.R. SP No. 52706, affirming the ruling of the Court of Tax Appeals
(CTA)[2] in CTA Case No. 5415.
The facts of the case are undisputed.
In 1994 and 1995, the respondent Bank of Commerce derived passive income in
the form of interests or discounts from its investments in government securities and
private commercial papers. On several occasions during the said period, it paid 5%
gross receipts tax on its income, as reflected in its quarterly percentage tax returns.
Included therein were the respondent banks passive income from the said investments
amounting to P85,384,254.51, which had already been subjected to a final tax of 20%.
Meanwhile, on January 30, 1996, the CTA rendered judgment in Asia Bank
Corporation v. Commissioner of Internal Revenue, CTA Case No. 4720, holding that the
20% final withholding tax on interest income from banks does not form part of taxable
gross receipts for Gross Receipts Tax (GRT) purposes. The CTA relied on Section 4(e)
of Revenue Regulations (Rev. Reg.) No. 12-80.
Relying on the said decision, the respondent bank filed an administrative claim for
refund with the Commissioner of Internal Revenue on July 19, 1996. It claimed that it
had overpaid its gross receipts tax for 1994 to 1995 by P853,842.54, computed as
follows:

Gross receipts subjected to

Final Tax Derived from Passive
Investment P85,384,254.51
x 20%
20% Final Tax Withheld 17,076,850.90
at Source x 5%
P 853,842.54

43 | P a g e
 Before the Commissioner could resolve the claim, the respondent bank filed a
petition for review with the CTA, lest it be barred by the mandatory two-year prescriptive
period under Section 230 of the Tax Code (now Section 229 of the Tax Reform Act of
1997).
In his answer to the petition, the Commissioner interposed the following special and
affirmative defenses:

5. The alleged refundable/creditable gross receipts taxes were collected and paid
pursuant to law and pertinent BIR implementing rules and regulations; hence, the
same are not refundable. Petitioner must prove that the income from which the
refundable/creditable taxes were paid from, were declared and included in its gross
income during the taxable year under review;

6. Petitioners allegation that it erroneously and excessively paid its gross receipt tax
during the year under review does not ipso facto warrant the refund/credit. Petitioner
must prove that the exclusions claimed by it from its gross receipts must be an
allowable exclusion under the Tax Code and its pertinent implementing Rules and
Regulations. Moreover, it must be supported by evidence;

7. Petitioner must likewise prove that the alleged refundable/creditable gross receipt
taxes were neither automatically applied as tax credit against its tax liability for the
succeeding quarter/s of the succeeding year nor included as creditable taxes declared
and applied to the succeeding taxable year/s;

8. Claims for tax refund/credit are construed in strictissimi juris against the taxpayer
as it partakes the nature of an exemption from tax and it is incumbent upon the
petitioner to prove that it is entitled thereto under the law. Failure on the part of the
petitioner to prove the same is fatal to its claim for tax refund/credit;

9. Furthermore, petitioner must prove that it has complied with the provision of
Section 230 (now Section 229) of the Tax Code, as amended. [3]

The CTA summarized the issues to be resolved as follows: whether or not the final
income tax withheld should form part of the gross receipts[4] of the taxpayer for GRT
purposes; and whether or not the respondent bank was entitled to a refund
of P853,842.54.[5]
The respondent bank averred that for purposes of computing the 5% gross receipts
tax, the final withholding tax does not form part of gross receipts.[6] On the other hand,
while the Commissioner conceded that the Court defined gross receipts as all receipts
of taxpayers excluding those which have been especially earmarked by law or
regulation for the government or some person other than the taxpayer in CIR v. Manila
Jockey Club, Inc.,[7] he claimed that such definition was applicable only to a proprietor of
an amusement place, not a banking institution which is an entirely different entity

44 | P a g e
altogether. As such, according to the Commissioner, the ruling of the Court in Manila
Jockey Club was inapplicable.
In its Decision dated April 27, 1999, the CTA by a majority decision [8] partially
granted the petition and ordered that the amount of P355,258.99 be refunded to the
respondent bank. The fallo of the decision reads:

WHEREFORE, in view of all the foregoing, respondent is

hereby ORDERED to REFUND in favor of petitioner Bank of Commerce the
amount of P355,258.99 representing validly proven erroneously withheld taxes from
interest income derived from its investments in government securities for the years
1994 and 1995. [9]

In ruling for respondent bank, the CTA relied on the ruling of the Court in Manila
Jockey Club, and held that the term gross receipts excluded those which had been
especially earmarked by law or regulation for the government or persons other than the
taxpayer. The CTA also cited its rulings in China Banking Corporation
v. CIR[10] and Equitable Banking Corporation v. CIR.[11]
The CTA ratiocinated that the aforesaid amount of P355,258.99 represented the
claim of the respondent bank, which was filed within the two-year mandatory
prescriptive period and was substantiated by material and relevant evidence. The CTA
applied Section 204(3) of the National Internal Revenue Code (NIRC). [12]
The Commissioner then filed a petition for review under Rule 43 of the Rules of
Court before the CA, alleging that:

(1) There is no provision of law which excludes the 20% final income tax
withheld under Section 50(a) of the Tax Code in the computation of the 5%
gross receipts tax.

(2) The Tax Court erred in applying the ruling in Collector of Internal Revenue
vs. Manila Jockey Club (108 Phil. 821) in the resolution of the legal issues
involved in the instant case.[13]

The Commissioner reiterated his stand that the ruling of this Court in Manila Jockey
Club, which was affirmed in Visayan Cebu Terminal Co., Inc. v. Commissioner of
Internal Revenue,[14] is not decisive. He averred that the factual milieu in the said case is
different, involving as it did the wager fund. The Commissioner further pointed out that
in Manila Jockey Club, the Court ruled that the race tracks commission did not form part
of the gross receipts, and as such were not subjected to the 20% amusement tax. On
the other hand, the issue in Visayan Cebu Terminal was whether or not the gross
receipts corresponding to 28% of the total gross income of the service contractor
delivered to the Bureau of Customs formed part of the gross receipts was subject to 3%
of contractors tax under Section 191 of the Tax Code. It was further pointed out that the
respondent bank, on the other hand, was a banking institution and not a contractor. The

45 | P a g e
petitioner insisted that the term gross receipts is self-evident; it includes all items of
income of the respondent bank regardless of whether or not the same were allocated or
earmarked for a specific purpose, to distinguish it from net receipts.
On August 14, 2001, the CA rendered judgment dismissing the petition. Citing
Sections 51 and 58(A) of the NIRC, Section 4(e) of Rev. Reg. No. 12-80[15] and the ruling
of this Court in Manila Jockey Club, the CA held that the P17,076,850.90 representing
the final withholding tax derived from passive investments subjected to final tax should
not be construed as forming part of the gross receipts of the respondent bank upon
which the 5% gross receipts tax should be imposed. The CA declared that the final
withholding tax in the amount of P17,768,509.00 was a trust fund for the government;
hence, does not form part of the respondents gross receipts. The legal ownership of the
amount had already been vested in the government. Moreover, the CA declared, the
respondent did not reap any benefit from the said amount. As such, subjecting the said
amount to the 5% gross receipts tax would result in double taxation. The appellate court
further cited CIR v. Tours Specialists, Inc.,[16] and declared that the ruling of the Court
in Manila Jockey Club was decisive of the issue.
The Commissioner now assails the said decision before this Court, contending that:

THE COURT OF APPEALS ERRED IN HOLDING THAT THE 20% FINAL

WITHHOLDING TAX ON BANKS INTEREST INCOME DOES NOT FORM
PART OF THE TAXABLE GROSS RECEIPTS IN COMPUTING THE 5% GROSS
RECEIPTS TAX (GRT, for brevity). [17]

The petitioner avers that the reliance by the CTA and the CA on Section 4(e) of
Rev. Reg. No. 12-80 is misplaced; the said provision merely authorizes the
determination of the amount of gross receipts based on the taxpayers method of
accounting under then Section 37 (now Section 43) of the Tax Code. The petitioner
asserts that the said provision ceased to exist as of October 15, 1984, when Rev. Reg.
No. 17-84 took effect. The petitioner further points out that under paragraphs 7(a) and
(c) of Rev. Reg. No. 17-84, interest income of financial institutions (including banks)
subject to withholding tax are included as part of the gross receipts upon which the
gross receipts tax is to be imposed. Citing the ruling of the CA in Commissioner of
Internal Revenue v. Asianbank Corporation[18] (which likewise cited Bank of America NT
& SA v. Court of Appeals,[19]) the petitioner posits that in computing the 5% gross
receipts tax, the income need not be actually received. For income to form part of the
taxable gross receipts, constructive receipt is enough. The petitioner is, likewise,
adamant in his claim that the final withholding tax from the respondent banks income
forms part of the taxable gross receipts for purposes of computing the 5% of gross
receipts tax. The petitioner posits that the ruling of this Court in Manila Jockey Club is
not decisive of the issue in this case.
The petition is meritorious.
The issues in this case had been raised and resolved by this Court in China
Banking Corporation v. Court of Appeals,[20] and CIR v. Solidbank Corporation.[21]

46 | P a g e
 Section 27(D)(1) of the Tax Code reads:

(D) Rates of Tax on Certain Passive Incomes.

(1) Interest from Deposits and Yield or any other Monetary Benefit from Deposit
Substitutes and from Trust Funds and Similar Arrangements, and Royalties. A
final tax at the rate of twenty percent (20%) is hereby imposed upon the amount of
interest on currency bank deposit and yield or any other monetary benefit from
deposit substitutes and from trust funds and similar arrangements received by
domestic corporations, and royalties, derived from sources within the
Philippines: Provided, however, That interest income derived by a domestic
corporation from a depository bank under the expanded foreign currency deposit
system shall be subject to a final income tax at the rate of seven and one-half percent
(7%) of such interest income.

On the other hand, Section 57(A)(B) of the Tax Code authorizes the withholding of
final tax on certain income creditable at source:

SEC. 57. Withholding of Tax at Source.

(A) Withholding of Final Tax on Certain Incomes. Subject to rules and

regulations, the Secretary of Finance may promulgate, upon the recommendation of
the Commissioner, requiring the filing of income tax return by certain income payees,
the tax imposed or prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1);
25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E); 27(D)(1), 27(D)(2), 27(D)(3),
27(D)(5); 28(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c), 28(B)(1),
28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of
this Code on specified items of income shall be withheld by payor-corporation and/or
person and paid in the same manner and subject to the same conditions as provided in
Section 58 of this Code.

(B) Withholding of Creditable Tax at Source. The Secretary of Finance may, upon
the recommendation of the Commissioner, require the withholding of a tax on the
items of income payable to natural or juridical persons, residing in the Philippines, by
payor-corporation/persons as provided for by law, at the rate of not less than one
percent (1%) but not more than thirty-two percent (32%) thereof, which shall be
credited against the income tax liability of the taxpayer for the taxable year.

The tax deducted and withheld by withholding agents under the said provision shall
be held as a special fund in trust for the government until paid to the collecting officer.[22]

47 | P a g e
 Section 121 (formerly Section 119) of the Tax Code provides that a tax on gross
receipts derived from sources within the Philippines by all banks and non-bank financial
intermediaries shall be computed in accordance with the schedules therein:

(a) On interest, commissions and discounts from lending activities as well as income
from financial leasing, on the basis of remaining maturities of instruments from which
such receipts are derived:

Short-term maturity (not in excess of two (2) years) 5%

Medium-term maturity (over two (2) years but

not exceeding four (4) years) 3%

Long-term maturity

(1) Over four (4) years but not exceeding

seven (7) years 1%

(2) Over seven (7) years 0%

(b) On dividends 0%

(c) On royalties, rentals of property, real or personal,

profits from exchange and all other items treated
as gross income under Section 32 of this Code 5%

Provided, however, That in case the maturity period referred to in paragraph (a) is
shortened thru pre-termination, then the maturity period shall be reckoned to end as
of the date of pre-termination for purposes of classifying the transaction as short,
medium or long-term and the correct rate of tax shall be applied accordingly.

Nothing in this Code shall preclude the Commissioner from imposing the same tax
herein provided on persons performing similar banking activities.

The Tax Code does not define gross receipts. Absent any statutory definition, the
Bureau of Internal Revenue has applied the term in its plain and ordinary meaning. [23]
In National City Bank v. CIR,[24] the CTA held that gross receipts should be
interpreted as the whole amount received as interest, without deductions; otherwise, if
deductions were to be made from gross receipts, it would be considered as net receipts.
The CTA changed course, however, when it promulgated its decision in Asia Bank; it
applied Section 4(e) of Rev. Reg. No. 12-80 and the ruling of this Court in Manila
Jockey Club, holding that the 20% final withholding tax on the petitioner banks interest

48 | P a g e
income should not form part of its taxable gross receipts, since the final tax was not
actually received by the petitioner bank but went to the coffers of the government.
The Court agrees with the contention of the petitioner that the appellate courts
reliance on Rev. Reg. No. 12-80, the rulings of the CTA in Asia Bank, and of this Court
in Manila Jockey Club has no legal and factual bases. Indeed, the Court ruled in China
Banking Corporation v. Court of Appeals[25] that:

In Far East Bank & Trust Co. v. Commissioner and Standard Chartered Bank v.
Commissioner, both promulgated on 16 November 2001, the tax court ruled that the
final withholding tax forms part of the banks gross receipts in computing the gross
receipts tax. The tax court held that Section 4(e) of Revenue Regulations No. 12-80
did not prescribe the computation of the amount of gross receipts but merely
authorized the determination of the amount of gross receipts on the basis of the
method of accounting being used by the taxpayer.

The word gross must be used in its plain and ordinary meaning. It is defined as
whole, entire, total, without deduction. A common definition is without
deduction.[26] Gross is also defined as taking in the whole; having no deduction or
abatement; whole, total as opposed to a sum consisting of separate or specified
parts.[27] Gross is the antithesis of net.[28] Indeed, in China Banking Corporation v. Court of
Appeals,[29] the Court defined the term in this wise:

As commonly understood, the term gross receipts means the entire receipts without
any deduction. Deducting any amount from the gross receipts changes the result, and
the meaning, to net receipts. Any deduction from gross receipts is inconsistent with a
law that mandates a tax on gross receipts, unless the law itself makes an exception. As
explained by the Supreme Court of Pennsylvania in Commonwealth of Pennsylvania
v. Koppers Company, Inc., -

Highly refined and technical tax concepts have been developed by the accountant and
legal technician primarily because of the impact of federal income tax legislation.
However, this in no way should affect or control the normal usage of words in the
construction of our statutes; and we see nothing that would require us not to include
the proceeds here in question in the gross receipts allocation unless statutorily such
inclusion is prohibited. Under the ordinary basic methods of handling accounts, the
term gross receipts, in the absence of any statutory definition of the term, must be
taken to include the whole total gross receipts without any deductions, x x
x. [Citations omitted] (Emphasis supplied)

Likewise, in Laclede Gas Co. v. City of St. Louis, the Supreme Court of Missouri
held:

49 | P a g e
The word gross appearing in the term gross receipts, as used in the ordinance, must
have been and was there used as the direct antithesis of the word net. In its usual and
ordinary meaning gross receipts of a business is the whole and entire amount of the
receipts without deduction, x x x. On the contrary, net receipts usually are the receipts
which remain after deductions are made from the gross amount thereof of the
expenses and cost of doing business, including fixed charges and depreciation. Gross
receipts become net receipts after certain proper deductions are made from the gross.
And in the use of the words gross receipts, the instant ordinance, of course, precluded
plaintiff from first deducting its costs and expenses of doing business, etc., in arriving
at the higher base figure upon which it must pay the 5% tax under this ordinance.
(Emphasis supplied)

Absent a statutory definition, the term gross receipts is understood in its plain and
ordinary meaning. Words in a statute are taken in their usual and familiar
signification, with due regard to their general and popular use. The Supreme Court of
Hawaii held in Bishop Trust Company v. Burns that -

xxx It is fundamental that in construing or interpreting a statute, in order to ascertain

the intent of the legislature, the language used therein is to be taken in the generally
accepted and usual sense. Courts will presume that the words in a statute were used to
express their meaning in common usage. This principle is equally applicable to a tax
statute. [Citations omitted] (Emphasis supplied)

The Court, likewise, declared that Section 121 of the Tax Code expressly subjects
interest income of banks to the gross receipts tax. Such express inclusion of interest
income in taxable gross receipts creates a presumption that the entire amount of the
interest income, without any deduction, is subject to the gross receipts tax. Indeed,
there is a presumption that receipts of a person engaging in business are subject to the
gross receipts tax. Such presumption may only be overcome by pointing to a specific
provision of law allowing such deduction of the final withholding tax from the taxable
gross receipts, failing which, the claim of deduction has no leg to stand on. Moreover,
where such an exception is claimed, the statute is construed strictly in favor of the
taxing authority. The exemption must be clearly and unambiguously expressed in the
statute, and must be clearly established by the taxpayer claiming the right thereto. Thus,
taxation is the rule and the claimant must show that his demand is within the letter as
well as the spirit of the law.[30]
In this case, there is no law which allows the deduction of 20% final tax from the
respondent banks interest income for the computation of the 5% gross receipts tax. On
the other hand, Section 8(a)(c), Rev. Reg. No. 17-84 provides that interest earned on
Philippine bank deposits and yield from deposit substitutes are included as part of the
tax base upon which the gross receipts tax is imposed. Such earned interest refers to
the gross interest without deduction since the regulations do not provide for any such
deduction. The gross interest, without deduction, is the amount the borrower pays, and

50 | P a g e
the income the lender earns, for the use by the borrower of the lenders money. The
amount of the final tax plainly covers for the interest earned and is consequently part of
the taxable gross receipt of the lender.[31]
The bare fact that the final withholding tax is a special trust fund belonging to the
government and that the respondent bank did not benefit from it while in custody of the
borrower does not justify its exclusion from the computation of interest income. Such
final withholding tax covers for the respondent banks income and is the amount to be
used to pay its tax liability to the government. This tax, along with the creditable
withholding tax, constitutes payment which would extinguish the respondent banks
obligation to the government. The bank can only pay the money it owns, or the money it
is authorized to pay.[32]
In the same vein, the respondent banks reliance on Section 4(e) of Rev. Reg. No.
12-80 and the ruling of the CTA in Asia Bank is misplaced. The Courts discussion
in China Banking Corporation[33] is instructive on this score:

CBC also relies on the Tax Courts ruling in Asia Bank that Section 4(e) of Revenue
Regulations No. 12-80 authorizes the exclusion of the final tax from the banks taxable
gross receipts. Section 4(e) provides that:

Sec. 4. x x x

(e) Gross receipts tax on banks, non-bank financial intermediaries, financing

companies, and other non-bank financial intermediaries not performing quasi-
banking functions. - The rates of taxes to be imposed on the gross receipts of such
financial institutions shall be based on all items of income actually received. Mere
accrual shall not be considered, but once payment is received on such accrual or in
cases of prepayment, then the amount actually received shall be included in the tax
base of such financial institutions, as provided hereunder: x x x. (Emphasis supplied
by Tax Court)

Section 4(e) states that the gross receipts shall be based on all items of income
actually received. The tax court in Asia Bank concluded that it is but logical to infer
that the final tax, not having been received by petitioner but instead went to the
coffers of the government, should no longer form part of its gross receipts for the
purpose of computing the GRT.

The Tax Court erred glaringly in interpreting Section 4(e) of Revenue Regulations
No. 12-80. Income may be taxable either at the time of its actual receipt or its accrual,
depending on the accounting method of the taxpayer. Section 4(e) merely provides for
an exception to the rule, making interest income taxable for gross receipts tax
purposes only upon actual receipt. Interest is accrued, and not actually received, when
the interest is due and demandable but the borrower has not actually paid and remitted

51 | P a g e
the interest, whether physically or constructively. Section 4(e) does not exclude
accrued interest income from gross receipts but merely postpones its inclusion until
actual payment of the interest to the lending bank. This is clear when Section 4(e)
states that [m]ere accrual shall not be considered, but once payment is received on
such accrual or in case of prepayment, then the amount actually received shall be
included in the tax base of such financial institutions x x x.

Actual receipt of interest income is not limited to physical receipt. Actual receipt may
either be physical receipt or constructive receipt. When the depository bank withholds
the final tax to pay the tax liability of the lending bank, there is prior to the
withholding a constructive receipt by the lending bank of the amount withheld. From
the amount constructively received by the lending bank, the depository bank deducts
the final withholding tax and remits it to the government for the account of the
lending bank. Thus, the interest income actually received by the lending bank, both
physically and constructively, is the net interest plus the amount withheld as final tax.

The concept of a withholding tax on income obviously and necessarily implies that
the amount of the tax withheld comes from the income earned by the taxpayer. Since
the amount of the tax withheld constitutes income earned by the taxpayer, then that
amount manifestly forms part of the taxpayers gross receipts. Because the amount
withheld belongs to the taxpayer, he can transfer its ownership to the government in
payment of his tax liability. The amount withheld indubitably comes from income of
the taxpayer, and thus forms part of his gross receipts.

The Court went on to explain in that case that far from supporting the petitioners
contention, its ruling in Manila Jockey Club, in fact even buttressed the contention of the
Commissioner. Thus:

CBC cites Collector of Internal Revenue v. Manila Jockey Club as authority that the
final withholding tax on interest income does not form part of a banks gross receipts
because the final tax is earmarked by regulation for the government. CBCs reliance on
the Manila Jockey Club is misplaced. In this case, the Court stated that Republic Act
No. 309 and Executive Order No. 320 apportioned the total amount of the bets in
horse races as follows:

87 % as dividends to holders of winning tickets, 12 % as commission of the Manila

Jockey Club, of which % was assigned to the Board of Races and 5% was distributed
as prizes for owners of winning horses and authorized bonuses for jockeys.

A subsequent law, Republic Act No. 1933 (RA No. 1933), amended the sharing by
ordering the distribution of the bets as follows:

52 | P a g e
Sec. 19. Distribution of receipts. The total wager funds or gross receipts from the sale
of pari-mutuel tickets shall be apportioned as follows: eighty-seven and one-half per
centum shall be distributed in the form of dividends among the holders of win, place
and show horses, as the case may be, in the regular races; six and one-half per centum
shall be set aside as the commission of the person, racetrack, racing club, or any
other entity conducting the races; five and one-half per centum shall be set aside for
the payment of stakes or prizes for win, place and show horses and authorized
bonuses for jockeys; and one-half per centum shall be paid to a special fund to be used
by the Games and Amusements Board to cover its expenses and such other purposes
authorized under this Act. xxx. (Emphasis supplied)

Under the distribution of receipts expressly mandated in Section 19 of RA No. 1933,

the gross receipts apportioned to Manila Jockey Club referred only to its own 6 %
commission. There is no dispute that the 5 % share of the horse-owners and jockeys,
and the % share of the Games and Amusements Board, do not form part of Manila
Jockey Clubs gross receipts. RA No. 1933 took effect on 22 June 1957, three years
before the Court decided Manila Jockey Club on 30 June 1960.

Even under the earlier law, Manila Jockey Club did not own the entire 12 %
commission. Manila Jockey Club owned, and could keep and use, only 7% of the total
bets. Manila Jockey Club merely held in trust the balance of 5 % for the benefit of the
Board of Races and the winning horse-owners and jockeys, the real owners of the 5
1/2 % share.

The Court in Manila Jockey Club quoted with approval the following Opinion of the
Secretary of Justice made prior to RA No. 1933:

There is no question that the Manila Jockey Club, Inc. owns only 7-1/2% [sic] of the
bets registered by the Totalizer. This portion represents its share or commission in the
total amount of money it handles and goes to the funds thereof as its own property
which it may legally disburse for its own purposes. The 5% [sic] does not belong to
the club. It is merely held in trust for distribution as prizes to the owners of winning
horses. It is destined for no other object than the payment of prizes and the club
cannot otherwise appropriate this portion without incurring liability to the owners of
winning horses. It can not be considered as an item of expense because the sum used
for the payment of prizes is not taken from the funds of the club but from a certain
portion of the total bets especially earmarked for that purpose. (Emphasis supplied)

Consequently, the Court ruled that the 5 % balance of the commission, not being
owned by Manila Jockey Club, did not form part of its gross receipts for purposes of
the amusement tax. Manila Jockey Club correctly paid the amusement tax based only
on its own 7% commission under RA No. 309 and Executive Order No. 320.
53 | P a g e
Manila Jockey Club does not support CBCs contention but rather the Commissioners
position. The Court ruled in Manila Jockey Club that receipts not owned by the
Manila Jockey Club but merely held by it in trust did not form part of Manila Jockey
Clubs gross receipts. Conversely, receipts owned by the Manila Jockey Club would
form part of its gross receipts.
[34]

We reverse the ruling of the CA that subjecting the Final Withholding Tax (FWT) to
the 5% of gross receipts tax would result in double taxation. In CIR v. Solidbank
Corporation,[35] we ruled, thus:

We have repeatedly said that the two taxes, subject of this litigation, are different from
each other. The basis of their imposition may be the same, but their natures are
different, thus leading us to a final point. Is there double taxation?

The Court finds none.

Double taxation means taxing the same property twice when it should be taxed only
once; that is, xxx taxing the same person twice by the same jurisdiction for the same
thing. It is obnoxious when the taxpayer is taxed twice, when it should be but once.
Otherwise described as direct duplicate taxation, the two taxes must be imposed on
the same subject matter, for the same purpose, by the same taxing authority, within
the same jurisdiction, during the same taxing period; and they must be of the same
kind or character.

First, the taxes herein are imposed on two different subject matters. The subject
matter of the FWT is the passive income generated in the form of interest on deposits
and yield on deposit substitutes, while the subject matter of the GRT is the privilege
of engaging in the business of banking.

A tax based on receipts is a tax on business rather than on the property; hence, it is an
excise rather than a property tax. It is not an income tax, unlike the FWT. In fact, we
have already held that one can be taxed for engaging in business and further taxed
differently for the income derived therefrom. Akin to our ruling in Velilla v.
Posadas, these two taxes are entirely distinct and are assessed under different
provisions.

Second, although both taxes are national in scope because they are imposed by the
same taxing authority the national government under the Tax Code and operate within
the same Philippine jurisdiction for the same purpose of raising revenues, the taxing
periods they affect are different. The FWT is deducted and withheld as soon as the
income is earned, and is paid after every calendar quarter in which it is earned. On the

54 | P a g e
other hand, the GRT is neither deducted nor withheld, but is paid only after every
taxable quarter in which it is earned.

Third, these two taxes are of different kinds or characters. The FWT is an income tax
subject to withholding, while the GRT is a percentage tax not subject to withholding.

In short, there is no double taxation, because there is no taxing twice, by the same
taxing authority, within the same jurisdiction, for the same purpose, in different taxing
periods, some of the property in the territory. Subjecting interest income to a 20%
FWT and including it in the computation of the 5% GRT is clearly not double
taxation.

IN LIGHT OF THE FOREGOING, the petition is GRANTED. The decision of the

Court of Appeals in CA-G.R. SP No. 52706 and that of the Court of Tax Appeals in CTA
Case No. 5415 are SET ASIDE and REVERSED. The CTA is hereby ORDERED to
DISMISS the petition of respondent Bank of Commerce. No costs.
SO ORDERED.
Austria-Martinez, (Acting Chairman), Tinga, and Chico-Nazario, JJ., concur.
Puno, (Chairman), on official leave.

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