CHAMBER OF REAL G.R. No.

160756 In this original petition for certiorari and mandamus,[1] petitioner Chamber of Real Estate
ESTATE AND BUILDERS and Builders Associations, Inc. is questioning the constitutionality of Section 27 (E) of
ASSOCIATIONS, INC., Republic Act (RA) 8424[2] and the revenue regulations (RRs) issued by the Bureau of
Petitioner, Present: Internal Revenue (BIR) to implement said provision and those involving creditable
PUNO, C.J., withholding taxes.[3]
CARPIO,
CORONA, Petitioner is an association of real estate developers and builders in the Philippines. It
CARPIO MORALES, impleaded former Executive Secretary Alberto Romulo, then acting Secretary of Finance
VELASCO, JR., Juanita D. Amatong and then Commissioner of Internal Revenue Guillermo Parayno, Jr. as
NACHURA, respondents.
- v e r s u s - LEONARDO-DE CASTRO,
BRION, Petitioner assails the validity of the imposition of minimum corporate income tax (MCIT)
PERALTA, on corporations and creditable withholding tax (CWT) on sales of real properties
BERSAMIN, classified as ordinary assets.
DEL CASTILLO,
ABAD, Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is
VILLARAMA, JR., implemented by RR 9-98. Petitioner argues that the MCIT violates the due process clause
PEREZ and because it levies income tax even if there is no realized gain.
MENDOZA, JJ.
Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and 2.58.2
THE HON. EXECUTIVE of RR 2-98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe the rules
SECRETARY ALBERTO ROMULO, and procedures for the collection of CWT on the sale of real properties categorized as
THE HON. ACTING SECRETARY OF ordinary assets. Petitioner contends that these revenue regulations are contrary to law
FINANCE JUANITA D. AMATONG, for two reasons: first, they ignore the different treatment by RA 8424 of ordinary assets
and THE HON. COMMISSIONER OF and capital assets and second, respondent Secretary of Finance has no authority to collect
INTERNAL REVENUE GUILLERMO CWT, much less, to base the CWT on the gross selling price or fair market value of the
PARAYNO, JR., real properties classified as ordinary assets.
Respondents. Promulgated:
Petitioner also asserts that the enumerated provisions of the subject revenue regulations
March 9, 2010 violate the due process clause because, like the MCIT, the government collects income
tax even when the net income has not yet been determined. They contravene the equal
protection clause as well because the CWT is being levied upon real estate enterprises
but not on other business enterprises, more particularly those in the manufacturing
sector.

The issues to be resolved are as follows:

(1) whether or not this Court should take cognizance of the present case;
x-------------------------------------------------x (2) whether or not the imposition of the MCIT on domestic corporations is
unconstitutional and
DECISION (3) whether or not the imposition of CWT on income from sales of real
properties classified as ordinary assets under RRs 2-98, 6-2001 and 7-
CORONA, J.: 2003, is unconstitutional.

OVERVIEW OF THE ASSAILED
PROVISIONS
Under the MCIT scheme, a corporation, beginning on its fourth year of
operation, is assessed an MCIT of 2% of its gross income when such MCIT is greater than
the normal corporate income tax imposed under Section 27(A).[4] If the regular income
tax is higher than the MCIT, the corporation does not pay the MCIT. Any excess of the
MCIT over the normal tax shall be carried forward and credited against the normal
income tax for the three immediately succeeding taxable years. Section 27(E) of RA 8424
provides:
Section 27 (E). [MCIT] on Domestic Corporations. -
(1) Imposition of Tax. A [MCIT] of two percent (2%) of
the gross income as of the end of the taxable year, as
defined herein, is hereby imposed on a corporation
taxable under this Title, beginning on the fourth
taxable year immediately following the year in which
such corporation commenced its business operations,
when the minimum income tax is greater than the tax
computed under Subsection (A) of this Section for the
taxable year.
(2) Carry Forward of Excess Minimum Tax. Any excess of
the [MCIT] over the normal income tax as computed
under Subsection (A) of this Section shall be carried
forward and credited against the normal income tax
for the three (3) immediately succeeding taxable
years.
(3) Relief from the [MCIT] under certain conditions. The
Secretary of Finance is hereby authorized to suspend
the imposition of the [MCIT] on any corporation
which suffers losses on account of prolonged labor
dispute, or because of force majeure, or because of
legitimate business reverses.
The Secretary of Finance is hereby authorized
to promulgate, upon recommendation of the
Commissioner, the necessary rules and regulations that
shall define the terms and conditions under which he
may suspend the imposition of the [MCIT] in a
meritorious case.
(4) Gross Income Defined. For purposes of applying the
[MCIT] provided under Subsection (E) hereof, the
term gross income shall mean gross sales less sales
returns, discounts and allowances and cost of goods
sold. Cost of goods sold shall include all business
expenses directly incurred to produce the
merchandise to bring them to their present location
and use.
For trading or merchandising concern, cost of
goods sold shall include the invoice cost of the goods
sold, plus import duties, freight in transporting the
goods to the place where the goods are actually sold
including insurance while the goods are in transit.
For a manufacturing concern, cost of goods
manufactured and sold shall include all costs of
production of finished goods, such as raw materials
used, direct labor and manufacturing overhead, freight
cost, insurance premiums and other costs incurred to
bring the raw materials to the factory or warehouse.
In the case of taxpayers engaged in the sale of
service, gross income means gross receipts less sales
returns, allowances, discounts and cost of
services. Cost of services shall mean all direct costs and
expenses necessarily incurred to provide the services
required by the customers and clients including (A)
salaries and employee benefits of personnel,
consultants and specialists directly rendering the
service and (B) cost of facilities directly utilized in
providing the service such as depreciation or rental of
equipment used and cost of supplies: Provided,
however, that in the case of banks, cost of services shall
include interest expense.
On August 25, 1998, respondent Secretary of Finance (Secretary), on the
recommendation of the Commissioner of Internal Revenue (CIR), promulgated RR 9-98
implementing Section 27(E).[5] The pertinent portions thereof read:
 Sec. 2.27(E) [MCIT] on Domestic Corporations.
(1) Imposition of the Tax. A [MCIT] of two percent (2%)
of the gross income as of the end of the taxable year
(whether calendar or fiscal year, depending on the
accounting period employed) is hereby imposed upon
any domestic corporation beginning the fourth (4th)
taxable year immediately following the taxable year in
which such corporation commenced its business
operations. The MCIT shall be imposed whenever such
corporation has zero or negative taxable income or
whenever the amount of minimum corporate income
tax is greater than the normal income tax due from
such corporation.
For purposes of these Regulations, the term,
normal income tax means the income tax rates
prescribed under Sec. 27(A) and Sec. 28(A)(1) of the
Code xxx at 32% effective January 1, 2000 and
thereafter.
xxx xxx xxx
(2) Carry forward of excess [MCIT]. Any excess of the
[MCIT] over the normal income tax as computed
under Sec. 27(A) of the Code shall be carried forward
on an annual basis and credited against the normal
income tax for the three (3) immediately succeeding
taxable years.
xxx xxx xxx
Meanwhile, on April 17, 1998, respondent Secretary, upon recommendation of
respondent CIR, promulgated RR 2-98 implementing certain provisions of RA 8424
involving the withholding of taxes.[6] Under Section 2.57.2(J) of RR No. 2-98, income
payments from the sale, exchange or transfer of real property, other than capital assets,
by persons residing in the Philippines and habitually engaged in the real estate business
were subjected to CWT:
Sec. 2.57.2. Income payment subject to [CWT] and rates
prescribed thereon:
xxx xxx xxx
(J) Gross selling price or total amount of consideration or its
equivalent paid to the seller/owner for the sale, exchange or transfer
of. Real property, other than capital assets, sold by an individual,
corporation, estate, trust, trust fund or pension fund and the
seller/transferor is habitually engaged in the real estate business in
accordance with the following schedule
Those which are exempt from a
withholding tax at source as prescribed in
Sec. 2.57.5 of these regulations.
Exempt
With a selling price of five hundred
thousand pesos (P500,000.00) or less.
1.5%
With a selling price of more than five
hundred thousand pesos (P500,000.00)
but not more than two million pesos
(P2,000,000.00).
3.0%
With selling price of more than two
million pesos (P2,000,000.00)
5.0%
xxx xxx xxx
Gross selling price shall mean the consideration stated in the sales
document or the fair market value determined in accordance with
Section 6 (E) of the Code, as amended, whichever is higher. In an
exchange, the fair market value of the property received in exchange,
as determined in the Income Tax Regulations shall be used.
Where the consideration or part thereof is payable on installment, no
withholding tax is required to be made on the periodic installment
payments where the buyer is an individual not engaged in trade or
business. In such a case, the applicable rate of tax based on the entire
consideration shall be withheld on the last installment or installments
to be paid to the seller.
 However, if the buyer is engaged in trade or business, whether a
corporation or otherwise, the tax shall be deducted and withheld by
the buyer on every installment.
This provision was amended by RR 6-2001 on July 31, 2001:
Sec. 2.57.2. Income payment subject to [CWT] and rates
prescribed thereon:
xxx xxx xxx
(J) Gross selling price or total amount of consideration or
its equivalent paid to the seller/owner for the sale,
exchange or transfer of real property classified as
ordinary asset. - A [CWT] based on the gross selling
price/total amount of consideration or the fair market
value determined in accordance with Section 6(E) of
the Code, whichever is higher, paid to the
seller/owner for the sale, transfer or exchange of real
property, other than capital asset, shall be imposed
upon the withholding agent,/buyer, in accordance
with the following schedule:
Where the seller/transferor is exempt from [CWT] in accordance
with Sec. 2.57.5 of these regulations.
Exempt
Upon the following values of real property, where the
seller/transferor is habitually engaged in the real estate business.
With a selling price of Five Hundred Thousand Pesos
(P500,000.00) or less. 1.5%
With a selling price of more than Five Hundred Thousand Pesos
(P500,000.00) but not more than Two Million Pesos
(P2,000,000.00).
3.0%
With a selling price of more than two Million
Pesos (P2,000,000.00). 5.0%
xxx xxx xxx
Gross selling price shall remain the consideration stated in
the sales document or the fair market value determined in
accordance with Section 6 (E) of the Code, as amended, whichever is
higher. In an exchange, the fair market value of the property received
in exchange shall be considered as the consideration.
xxx xxx xxx
However, if the buyer is engaged in trade or business,
whether a corporation or otherwise, these rules shall apply:
(i) If the sale is a sale of property on the
installment plan (that is, payments in the year of
sale do not exceed 25% of the selling price), the
tax shall be deducted and withheld by the buyer
on every installment.
(ii) If, on the other hand, the sale is on a cash basis
or is a deferred-payment sale not on the
installment plan (that is, payments in the year of
sale exceed 25% of the selling price), the buyer
shall withhold the tax based on the gross selling
price or fair market value of the property,
whichever is higher, on the first installment.
In any case, no Certificate Authorizing Registration (CAR)
shall be issued to the buyer unless the [CWT] due on the sale, transfer
or exchange of real property other than capital asset has been fully
paid. (Underlined amendments in the original)
Section 2.58.2 of RR 2-98 implementing Section 58(E) of RA 8424 provides that
any sale, barter or exchange subject to the CWT will not be recorded by the Registry of
Deeds until the CIR has certified that such transfers and conveyances have been reported
and the taxes thereof have been duly paid:[7]
Sec. 2.58.2. Registration with the Register of Deeds. Deeds of
conveyances of land or land and building/improvement thereon
arising from sales, barters, or exchanges subject to the creditable
expanded withholding tax shall not be recorded by the Register of
Deeds unless the [CIR] or his duly authorized representative has
certified that such transfers and conveyances have been reported
and the expanded withholding tax, inclusive of the documentary
stamp tax, due thereon have been fully paid xxxx.
On February 11, 2003, RR No. 7-2003[8] was promulgated, providing for the guidelines in
determining whether a particular real property is a capital or an ordinary asset for
purposes of imposing the MCIT, among others. The pertinent portions thereof state:
 Section 4. Applicable taxes on sale, exchange or
other disposition of real property. - Gains/Income derived
from sale, exchange, or other disposition of real properties
shall, unless otherwise exempt, be subject to applicable
taxes imposed under the Code, depending on whether the
subject properties are classified as capital assets or
ordinary assets;
a. In the case of individual citizen (including estates
and trusts), resident aliens, and non-resident aliens
engaged in trade or business in the Philippines;
xxx xxx xxx
(ii) The sale of real property located in the
Philippines, classified as ordinary assets,
shall be subject to the [CWT] (expanded)
under Sec. 2.57..2(J) of [RR 2-98], as
amended, based on the gross selling
price or current fair market value as
determined in accordance with Section
6(E) of the Code, whichever is higher,
and consequently, to the ordinary
income tax imposed under Sec.
24(A)(1)(c) or 25(A)(1) of the Code, as
the case may be, based on net taxable
income.
xxx xxx xxx
c. In the case of domestic corporations.
xxx xxx xxx
(ii) The sale of land and/or building classified as
ordinary asset and other real property (other than
land and/or building treated as capital asset),
regardless of the classification thereof, all of which
are located in the Philippines, shall be subject to
the [CWT] (expanded) under Sec. 2.57.2(J) of [RR
2-98], as amended, and consequently, to the
ordinary income tax under Sec. 27(A) of the
Code. In lieu of the ordinary income tax, however,
domestic corporations may become subject to the
[MCIT] under Sec. 27(E) of the Code, whichever is
applicable.
xxx xxx xxx
We shall now tackle the issues raised.
EXISTENCE OF A JUSTICIABLE CONTROVERSY
Courts will not assume jurisdiction over a constitutional question unless the
following requisites are satisfied: (1) there must be an actual case calling for the exercise
of judicial review; (2) the question before the court must be ripe for
adjudication; (3) the person challenging the validity of the act must have standing to do
so; (4) the question of constitutionality must have been raised at the earliest opportunity
and (5) the issue of constitutionality must be the very lis mota of the case.[9]
Respondents aver that the first three requisites are absent in this
case. According to them, there is no actual case calling for the exercise of judicial power
and it is not yet ripe for adjudication because
[petitioner] did not allege that CREBA, as a corporate entity, or any of
its members, has been assessed by the BIR for the payment of [MCIT]
or [CWT] on sales of real property. Neither did petitioner allege that
its members have shut down their businesses as a result of the
payment of the MCIT or CWT. Petitioner has raised concerns in mere
abstract and hypothetical form without any actual, specific and
concrete instances cited that the assailed law and revenue regulations
have actually and adversely affected it. Lacking empirical data on
which to base any conclusion, any discussion on the constitutionality
of the MCIT or CWT on sales of real property is essentially an
academic exercise.
Perceived or alleged hardship to taxpayers alone is not an adequate
justification for adjudicating abstract issues. Otherwise, adjudication
would be no different from the giving of advisory opinion that does
not really settle legal issues.[10]
An actual case or controversy involves a conflict of legal rights or an assertion
of opposite legal claims which is susceptible of judicial resolution as distinguished from a
hypothetical or abstract difference or dispute.[11] On the other hand, a question is
considered ripe for adjudication when the act being challenged has a direct adverse
effect on the individual challenging it.[12]
Contrary to respondents assertion, we do not have to wait until petitioners
members have shut down their operations as a result of the MCIT or CWT. The assailed
provisions are already being implemented. As we stated in Didipio Earth-Savers Multi-
Purpose Association, Incorporated (DESAMA) v. Gozun:[13]
By the mere enactment of the questioned law or the
approval of the challenged act, the dispute is said to have ripened into
a judicial controversy even without any other overt act. Indeed, even a
singular violation of the Constitution and/or the law is enough to
awaken judicial duty.[14]
If the assailed provisions are indeed unconstitutional, there is no better time than the
present to settle such question once and for all.
Respondents next argue that petitioner has no legal standing to sue:
Petitioner is an association of some of the real estate
developers and builders in the Philippines. Petitioners did not allege
that [it] itself is in the real estate business. It did not allege any
material interest or any wrong that it may suffer from the
enforcement of [the assailed provisions].[15]
Legal standing or locus standi is a partys personal and substantial interest in a
case such that it has sustained or will sustain direct injury as a result of the
governmental act being challenged.[16] In Holy Spirit Homeowners Association, Inc. v.
Defensor,[17] we held that the association had legal standing because its members stood
to be injured by the enforcement of the assailed provisions:
Petitioner association has the legal standing to institute the
instant petition xxx. There is no dispute that the individual members
of petitioner association are residents of the NGC. As such they are
covered and stand to be either benefited or injured by the
enforcement of the IRR, particularly as regards the selection process
of beneficiaries and lot allocation to qualified beneficiaries. Thus,
petitioner association may assail those provisions in the IRR which it
believes to be unfavorable to the rights of its members. xxx Certainly,
petitioner and its members have sustained direct injury arising from
the enforcement of the IRR in that they have been disqualified and
eliminated from the selection process.[18]
In any event, this Court has the discretion to take cognizance of a suit which does not
satisfy the requirements of an actual case, ripeness or legal standing when paramount
public interest is involved.[19] The questioned MCIT and CWT affect not only petitioners
but practically all domestic corporate taxpayers in our country. The transcendental
importance of the issues raised and their overreaching significance to society make it
proper for us to take cognizance of this petition.[20]
CONCEPT AND RATIONALE OF
THE MCIT
The MCIT on domestic corporations is a new concept introduced by RA 8424 to
the Philippine taxation system. It came about as a result of the perceived inadequacy of
the self-assessment system in capturing the true income of corporations.[21] It was
devised as a relatively simple and effective revenue-raising instrument compared to the
normal income tax which is more difficult to control and enforce. It is a means to
ensure that everyone will make some minimum contribution to the support of the public
sector. The congressional deliberations on this are illuminating:
Senator Enrile. Mr. President, we are not unmindful of the practice of
certain corporations of reporting constantly a loss in their operations
to avoid the payment of taxes, and thus avoid sharing in the cost of
government. In this regard, the Tax Reform Act introduces for the first
time a new concept called the [MCIT] so as to minimize tax evasion,
tax avoidance, tax manipulation in the country and for administrative
convenience. This will go a long way in ensuring that corporations will
pay their just share in supporting our public life and our economic
advancement.[22]
Domestic corporations owe their corporate existence and their privilege to do
business to the government. They also benefit from the efforts of the government to
improve the financial market and to ensure a favorable business climate. It is therefore
fair for the government to require them to make a reasonable contribution to the public
expenses.
Congress intended to put a stop to the practice of corporations which, while
having large turn-overs, report minimal or negative net income resulting in minimal or
zero income taxes year in and year out, through under-declaration of income or over-
deduction of expenses otherwise called tax shelters.[23]
Mr. Javier (E.) [This] is what the Finance Dept. is trying to remedy,
that is why they have proposed the [MCIT]. Because from experience
too, you have corporations which have been losing year in and year
out and paid no tax. So, if the corporation has been losing for the past
 five years to ten years, then that corporation has no business to be in
business. It is dead. Why continue if you are losing year in and year
out? So, we have this provision to avoid this type of tax shelters, Your
Honor.[24]
The primary purpose of any legitimate business is to earn a profit. Continued
and repeated losses after operations of a corporation or consistent reports of minimal
net income render its financial statements and its tax payments suspect. For sure, certain
tax avoidance schemes resorted to by corporations are allowed in our jurisdiction. The
MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax
evasion and minimizes tax avoidance schemes achieved through sophisticated and artful
manipulations of deductions and other stratagems. Since the tax base was broader, the
tax rate was lowered.
To further emphasize the corrective nature of the MCIT, the following safeguards were
incorporated into the law:
First, recognizing the birth pangs of businesses and the reality of the need to
recoup initial major capital expenditures, the imposition of the MCIT commences only on
the fourth taxable year immediately following the year in which the corporation
commenced its operations.[25] This grace period allows a new business to stabilize first
and make its ventures viable before it is subjected to the MCIT.[26]
Second, the law allows the carrying forward of any excess of the MCIT paid over
the normal income tax which shall be credited against the normal income tax for the
three immediately succeeding years.[27]
Third, since certain businesses may be incurring genuine repeated losses, the
law authorizes the Secretary of Finance to suspend the imposition of MCIT if a
corporation suffers losses due to prolonged labor dispute, force majeure and legitimate
business reverses.[28]
Even before the legislature introduced the MCIT to the Philippine taxation
system, several other countries already had their own system of minimum corporate
income taxation. Our lawmakers noted that most developing countries, particularly Latin
American and Asian countries, have the same form of safeguards as we do. As pointed
out during the committee hearings:
[Mr. Medalla:] Note that most developing countries where you have
of course quite a bit of room for underdeclaration of gross receipts
have this same form of safeguards.
In the case of Thailand, half a percent (0.5%), theres a minimum of
income tax of half a percent (0.5%) of gross assessable income. In
Korea a 25% of taxable income before deductions and exemptions. Of
course the different countries have different basis for that minimum
income tax.
The other thing youll notice is the preponderance of Latin American
countries that employed this method. Okay, those are additional
Latin American countries.[29]
At present, the United States of America, Mexico, Argentina, Tunisia, Panama and
Hungary have their own versions of the MCIT.[30]
MCIT IS NOT VIOLATIVE OF
DUE PROCESS
Petitioner claims that the MCIT under Section 27(E) of RA 8424 is unconstitutional
because it is highly oppressive, arbitrary and confiscatory which amounts to deprivation
of property without due process of law. It explains that gross income as defined under
said provision only considers the cost of goods sold and other direct expenses; other
major expenditures, such as administrative and interest expenses which are equally
necessary to produce gross income, were not taken into account.[31] Thus, pegging the tax
base of the MCIT to a corporations gross income is tantamount to a confiscation of
capital because gross income, unlike net income, is not realized gain.[32]
We disagree.
Taxes are the lifeblood of the government. Without taxes, the government can
neither exist nor endure. The exercise of taxing power derives its source from the very
existence of the State whose social contract with its citizens obliges it to promote public
interest and the common good.[33]
Taxation is an inherent attribute of sovereignty.[34] It is a power that is purely
legislative.[35] Essentially, this means that in the legislature primarily lies the discretion
to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and
situs (place) of taxation.[36] It has the authority to prescribe a certain tax at a specific rate
for a particular public purpose on persons or things within its jurisdiction. In other
words, the legislature wields the power to define what tax shall be imposed, why it
should be imposed, how much tax shall be imposed, against whom (or what) it shall be
imposed and where it shall be imposed.
As a general rule, the power to tax is plenary and unlimited in its range, acknowledging
in its very nature no limits, so that the principal check against its abuse is to be found
only in the responsibility of the legislature (which imposes the tax) to its constituency
who are to pay it.[37] Nevertheless, it is circumscribed by constitutional limitations. At the
same time, like any other statute, tax legislation carries a presumption of
constitutionality.
The constitutional safeguard of due process is embodied in the fiat [no] person
shall be deprived of life, liberty or property without due process of law. In Sison, Jr. v.
Ancheta, et al.,[38] we held that the due process clause may properly be invoked to
invalidate, in appropriate cases, a revenue measure [39] when it amounts to a confiscation
of property.[40] But in the same case, we also explained that we will not strike down a
revenue measure as unconstitutional (for being violative of the due process clause) on
the mere allegation of arbitrariness by the taxpayer.[41] There must be a factual
foundation to such an unconstitutional taint.[42] This merely adheres to the authoritative
doctrine that, where the due process clause is invoked, considering that it is not a fixed
rule but rather a broad standard, there is a need for proof of such persuasive
character.[43]
Petitioner is correct in saying that income is distinct from capital.[44] Income
means all the wealth which flows into the taxpayer other than a mere return on
capital.Capital is a fund or property existing at one distinct point in time while income
denotes a flow of wealth during a definite period of time.[45] Income is gain derived and
severed from capital.[46] For income to be taxable, the following requisites must exist:
(1) there must be gain;
(2) the gain must be realized or received and
(3) the gain must not be excluded by law or treaty from
taxation.[47]
Certainly, an income tax is arbitrary and confiscatory if it taxes capital because capital is
not income. In other words, it is income, not capital, which is subject to income
tax.However, the MCIT is not a tax on capital.
The MCIT is imposed on gross income which is arrived at by deducting the
capital spent by a corporation in the sale of its goods, i.e., the cost of goods[48] and other
direct expenses from gross sales. Clearly, the capital is not being taxed.
Furthermore, the MCIT is not an additional tax imposition. It is imposed in lieu of the
normal net income tax, and only if the normal income tax is suspiciously low. The MCIT
merely approximates the amount of net income tax due from a corporation, pegging the
rate at a very much reduced 2% and uses as the base the corporations gross income.
Besides, there is no legal objection to a broader tax base or taxable income by
eliminating all deductible items and at the same time reducing the applicable tax rate.[49]
Statutes taxing the gross "receipts," "earnings," or
"income" of particular corporations are found in many
jurisdictions. Tax thereon is generally held to be within the power of a
state to impose; or constitutional, unless it interferes with interstate
commerce or violates the requirement as to uniformity of taxation.[50]
The United States has a similar alternative minimum tax (AMT) system which is
generally characterized by a lower tax rate but a broader tax base.[51] Since our income
tax laws are of American origin, interpretations by American courts of our parallel tax
laws have persuasive effect on the interpretation of these laws. [52] Although our MCIT is
not exactly the same as the AMT, the policy behind them and the procedure of their
implementation are comparable. On the question of the AMTs constitutionality, the
United States Court of Appeals for the Ninth Circuit stated in Okin v. Commissioner:[53]
In enacting the minimum tax, Congress attempted to remedy general
taxpayer distrust of the system growing from large numbers of
taxpayers with large incomes who were yet paying no taxes.
xxx xxx xxx
We thus join a number of other courts in upholding the
constitutionality of the [AMT]. xxx [It] is a rational means of obtaining
a broad-based tax, and therefore is constitutional.[54]
The U.S. Court declared that the congressional intent to ensure that corporate taxpayers
would contribute a minimum amount of taxes was a legitimate governmental end to
which the AMT bore a reasonable relation.[55]
American courts have also emphasized that Congress has the power to condition, limit or
deny deductions from gross income in order to arrive at the net that it chooses to
tax.[56] This is because deductions are a matter of legislative grace.[57]
Absent any other valid objection, the assignment of gross income, instead of net
income, as the tax base of the MCIT, taken with the reduction of the tax rate from 32% to
2%, is not constitutionally objectionable.
Moreover, petitioner does not cite any actual, specific and concrete negative
experiences of its members nor does it present empirical data to show that the
implementation of the MCIT resulted in the confiscation of their property.
In sum, petitioner failed to support, by any factual or legal basis, its allegation
that the MCIT is arbitrary and confiscatory. The Court cannot strike down a law as
unconstitutional simply because of its yokes.[58] Taxation is necessarily burdensome
because, by its nature, it adversely affects property rights.[59] The party alleging the laws
unconstitutionality has the burden to demonstrate the supposed violations in
understandable terms.[60]
RR 9-98 MERELY CLARIFIES to RA 8424 which calls for the payment of the net income at the end of the taxable
SECTION 27(E) OF RA 8424 period.[63]
Petitioner theorizes that since RA 8424 treats capital assets and ordinary assets
differently, respondents cannot disregard the distinctions set by the legislators as
Petitioner alleges that RR 9-98 is a deprivation of property without due process regards the tax base, modes of collection and payment of taxes on income from the sale
of law because the MCIT is being imposed and collected even when there is actually a of capital and ordinary assets.
loss, or a zero or negative taxable income: Petitioners arguments have no merit.
Sec. 2.27(E) [MCIT] on Domestic Corporations.

(1) Imposition of the Tax. xxx The MCIT shall be imposed whenever AUTHORITY OF THE
such corporation has zero or negative taxable income or whenever SECRETARY OF FINANCE
the amount of [MCIT] is greater than the normal income tax due from TO ORDER THE
such corporation. (Emphasis supplied) COLLECTION OF CWT ON
SALES OF REAL
RR 9-98, in declaring that MCIT should be imposed whenever such corporation PROPERTY CONSIDERED
has zero or negative taxable income, merely defines the coverage of Section 27(E). This AS ORDINARY ASSETS
means that even if a corporation incurs a net loss in its business operations or reports
zero income after deducting its expenses, it is still subject to an MCIT of 2% of its gross
income. This is consistent with the law which imposes the MCIT on gross income The Secretary of Finance is granted, under Section 244 of RA 8424, the
notwithstanding the amount of the net income. But the law also states that the MCIT is to authority to promulgate the necessary rules and regulations for the effective
be paid only if it is greater than the normal net income. Obviously, it may well be the case enforcement of the provisions of the law. Such authority is subject to the limitation that
that the MCIT would be less than the net income of the corporation which posts a zero or the rules and regulations must not override, but must remain consistent and in harmony
negative taxable income. with, the law they seek to apply and implement.[64] It is well-settled that an
administrative agency cannot amend an act of Congress.[65]
We now proceed to the issues involving the CWT.
We have long recognized that the method of withholding tax at source is a procedure of
The withholding tax system is a procedure through which taxes (including collecting income tax which is sanctioned by our tax laws.[66] The withholding tax system
income taxes) are collected.[61] Under Section 57 of RA 8424, the types of income subject was devised for three primary reasons: first, to provide the taxpayer a convenient
to withholding tax are divided into three categories: (a) withholding of final tax on manner to meet his probable income tax liability; second, to ensure the collection of
certain incomes; (b) withholding of creditable tax at source and (c) tax-free covenant income tax which can otherwise be lost or substantially reduced through failure to file
bonds. Petitioner is concerned with the second category (CWT) and maintains that the the corresponding returns and third, to improve the governments cash flow.[67] This
revenue regulations on the collection of CWT on sale of real estate categorized as results in administrative savings, prompt and efficient collection of taxes, prevention of
ordinary assets are unconstitutional. delinquencies and reduction of governmental effort to collect taxes through more
complicated means and remedies.[68]
Petitioner, after enumerating the distinctions between capital and ordinary Respondent Secretary has the authority to require the withholding of a tax on
assets under RA 8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and items of income payable to any person, national or juridical, residing in the
Sections 4(a)(ii) and (c)(ii) of RR 7-2003 were promulgated with grave abuse of Philippines.Such authority is derived from Section 57(B) of RA 8424 which provides:
discretion amounting to lack of jurisdiction and patently in contravention of
law[62] because they ignore such distinctions. Petitioners conclusion is based on the SEC. 57. Withholding of Tax at Source.
following premises: (a) the revenue regulations use gross selling price (GSP) or fair
market value (FMV) of the real estate as basis for determining the income tax for the sale xxx xxx xxx
of real estate classified as ordinary assets and (b) they mandate the collection of income
tax on a per transaction basis, i.e., upon consummation of the sale via the CWT, contrary (B) Withholding of Creditable Tax at Source. The
[Secretary] may, upon the recommendation of the
 [CIR], 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 questioned provisions of RR 2-98, as amended, are well within the
authority given by Section 57(B) to the Secretary, i.e., the graduated rate of 1.5%-5% is
between the 1%-32% range; the withholding tax is imposed on the income payable and
the tax is creditable against the income tax liability of the taxpayer for the taxable year.
EFFECT OF RRS ON THE
TAX BASE FOR THE
INCOME TAX OF
INDIVIDUALS OR
CORPORATIONS
ENGAGED IN THE REAL
ESTATE BUSINESS
Petitioner maintains that RR 2-98, as amended, arbitrarily shifted the tax base of a real
estate business income tax from net income to GSP or FMV of the property sold.
Petitioner is wrong.
The taxes withheld are in the nature of advance tax payments by a taxpayer in order to
extinguish its possible tax obligation. [69] They are installments on the annual tax which
may be due at the end of the taxable year.[70]
Under RR 2-98, the tax base of the income tax from the sale of real property
classified as ordinary assets remains to be the entitys net income imposed under Section
24 (resident individuals) or Section 27 (domestic corporations) in relation to Section 31
of RA 8424, i.e. gross income less allowable deductions. The CWT is to be deducted from
the net income tax payable by the taxpayer at the end of the taxable year.[71] Precisely,
Section 4(a)(ii) and (c)(ii) of RR 7-2003 reiterate that the tax base for the sale of real
property classified as ordinary assets remains to be the net taxable income:
Section 4. Applicable taxes on sale, exchange or other disposition of
real property. - Gains/Income derived from sale, exchange, or other
disposition of real properties shall unless otherwise exempt, be
subject to applicable taxes imposed under the Code, depending on
whether the subject properties are classified as capital assets or
ordinary assets;
xxx xxx xxx
a. In the case of individual citizens (including estates
and trusts), resident aliens, and non-resident aliens
engaged in trade or business in the Philippines;
xxx xxx xxx
(ii) The sale of real property located in the Philippines, classified as
ordinary assets, shall be subject to the [CWT] (expanded) under Sec.
2.57.2(j) of [RR 2-98], as amended, based on the [GSP] or current
[FMV] as determined in accordance with Section 6(E) of the Code,
whichever is higher, and consequently, to the ordinary income tax
imposed under Sec. 24(A)(1)(c) or 25(A)(1) of the Code, as the
case may be, based on net taxable income.
xxx xxx xxx
c. In the case of domestic corporations.
The sale of land and/or building classified as ordinary asset and
other real property (other than land and/or building treated as
capital asset), regardless of the classification thereof, all of which are
located in the Philippines, shall be subject to the [CWT] (expanded)
under Sec. 2.57.2(J) of [RR 2-98], as amended, and consequently,
to the ordinary income tax under Sec. 27(A) of the Code. In lieu of
the ordinary income tax, however, domestic corporations may
become subject to the [MCIT] under Sec. 27(E) of the same Code,
whichever is applicable. (Emphasis supplied)
Accordingly, at the end of the year, the taxpayer/seller shall file its income tax return and
credit the taxes withheld (by the withholding agent/buyer) against its tax due. If the tax
due is greater than the tax withheld, then the taxpayer shall pay the difference. If, on the
other hand, the tax due is less than the tax withheld, the taxpayer will be entitled to a
refund or tax credit. Undoubtedly, the taxpayer is taxed on its net income.
The use of the GSP/FMV as basis to determine the withholding taxes is
evidently for purposes of practicality and convenience. Obviously, the withholding
agent/buyer who is obligated to withhold the tax does not know, nor is he privy to, how
much the taxpayer/seller will have as its net income at the end of the taxable
year. Instead, said withholding agents knowledge and privity are limited only to the
particular transaction in which he is a party. In such a case, his basis can only be the GSP
or FMV as these are the only factors reasonably known or knowable by him in As previously stated, FWT is imposed on the sale of capital assets. On the other hand,
connection with the performance of his duties as a withholding agent. CWT is imposed on the sale of ordinary assets. The inherent and substantial differences
between FWT and CWT disprove petitioners contention that ordinary assets are being
lumped together with, and treated similarly as, capital assets in contravention of the
NO BLURRING OF pertinent provisions of RA 8424.
DISTINCTIONS
BETWEEN ORDINARY Petitioner insists that the levy, collection and payment of CWT at the time of
ASSETS AND CAPITAL transaction are contrary to the provisions of RA 8424 on the manner and time of filing of
ASSETS the return, payment and assessment of income tax involving ordinary assets.[75]
The fact that the tax is withheld at source does not automatically mean that it is
treated exactly the same way as capital gains. As aforementioned, the mechanics of the
RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real FWT are distinct from those of the CWT. The withholding agent/buyers act of collecting
property categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA 8424 the tax at the time of the transaction by withholding the tax due from the income payable
imposes a final tax and flat rate of 6% on the gain presumed to be realized from the sale is the essence of the withholding tax method of tax collection.
of a capital asset based on its GSP or FMV. This final tax is also withheld at source.[72]
The differences between the two forms of withholding tax, i.e., creditable and NO RULE THAT ONLY PASSIVE
final, show that ordinary assets are not treated in the same manner as capital assets. INCOMES CAN BE SUBJECT TO
Final withholding tax (FWT) and CWT are distinguished as follows: CWT

Petitioner submits that only passive income can be subjected to withholding

FWT
a) The amount of income tax
withheld by the withholding
agent is constituted as a full
and final payment of the
income tax due from the payee
on the said income.
CWT
a) Taxes withheld on certain
income payments are intended
to equal or at least approximate
the tax due of the payee on said
income.
tax, whether final or creditable. According to petitioner, the whole of Section 57 governs
the withholding of income tax on passive income. The enumeration in Section 57(A)
refers to passive income being subjected to FWT. It follows that Section 57(B) on CWT
should also be limited to passive income:
SEC. 57. Withholding of Tax at Source.

b)The liability for payment of
the tax rests primarily on the
payor as a withholding agent.
c) The payee is not required to
file an income tax return for the
particular income.[73]
b) Payee of income is required to
report the income and/or pay
the difference between the tax
withheld and the tax due on the
income. The payee also has the
right to ask for a refund if the tax
withheld is more than the tax
due.
c) The income recipient is still
required to file an income tax
return, as prescribed in Sec. 51
and Sec. 52 of the NIRC, as
amended.[74]
(A) Withholding of Final Tax on Certain Incomes. Subject to rules and
regulations, the [Secretary] may promulgate, upon the
recommendation of the [CIR], 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] may,
upon the recommendation of the [CIR], 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. (Emphasis supplied)
This line of reasoning is non sequitur.
Section 57(A) expressly states that final tax can be imposed on certain kinds of
income and enumerates these as passive income. The BIR defines passive income by
stating what it is not:
if the income is generated in the active pursuit and
performance of the corporations primary purposes, the same is not
passive income[76]
It is income generated by the taxpayers assets. These assets can be in the form of real
properties that return rental income, shares of stock in a corporation that earn dividends
or interest income received from savings.
On the other hand, Section 57(B) provides that the Secretary can require a CWT
on income payable to natural or juridical persons, residing in the Philippines. There is no
requirement that this income be passive income. If that were the intent of Congress, it
could have easily said so.
Indeed, Section 57(A) and (B) are distinct. Section 57(A) refers to FWT while Section
57(B) pertains to CWT. The former covers the kinds of passive income enumerated
therein and the latter encompasses any income other than those listed in 57(A). Since the
law itself makes distinctions, it is wrong to regard 57(A) and 57(B) in the same way.
To repeat, the assailed provisions of RR 2-98, as amended, do not modify or
deviate from the text of Section 57(B). RR 2-98 merely implements the law by specifying
what income is subject to CWT. It has been held that, where a statute does not require
any particular procedure to be followed by an administrative agency, the agency may
adopt any reasonable method to carry out its functions.[77] Similarly, considering that the
law uses the general term income, the Secretary and CIR may specify the kinds of income
the rules will apply to based on what is feasible. In addition, administrative rules and
regulations ordinarily deserve to be given weight and respect by the courts[78] in view of
the rule-making authority given to those who formulate them and their specific expertise
in their respective fields.
NO DEPRIVATION OF
PROPERTY
WITHOUT DUE PROCESS
Petitioner avers that the imposition of CWT on GSP/FMV of real estate
classified as ordinary assets deprives its members of their property without due process
of law because, in their line of business, gain is never assured by mere receipt of the
selling price. As a result, the government is collecting tax from net income not yet gained
or earned.
Again, it is stressed that the CWT is creditable against the tax due from the seller of the
property at the end of the taxable year. The seller will be able to claim a tax refund if its
net income is less than the taxes withheld. Nothing is taken that is not due so there is no
confiscation of property repugnant to the constitutional guarantee of due process.More
importantly, the due process requirement applies to the power to tax.[79] The CWT does
not impose new taxes nor does it increase taxes.[80] It relates entirely to the method and
time of payment.
Petitioner protests that the refund remedy does not make the CWT less
burdensome because taxpayers have to wait years and may even resort to litigation
before they are granted a refund.[81] This argument is misleading. The practical problems
encountered in claiming a tax refund do not affect the constitutionality and validity of the
CWT as a method of collecting the tax.
Petitioner complains that the amount withheld would have otherwise been
used by the enterprise to pay labor wages, materials, cost of money and other expenses
which can then save the entity from having to obtain loans entailing considerable
interest expense. Petitioner also lists the expenses and pitfalls of the trade which add to
the burden of the realty industry: huge investments and borrowings; long gestation
period; sudden and unpredictable interest rate surges; continually spiraling
development/construction costs; heavy taxes and prohibitive up-front regulatory fees
from at least 20 government agencies.[82]
Petitioners lamentations will not support its attack on the constitutionality of
the CWT. Petitioners complaints are essentially matters of policy best addressed to the
executive and legislative branches of the government. Besides, the CWT is applied only
on the amounts actually received or receivable by the real estate entity. Sales on
installment are taxed on a per-installment basis.[83] Petitioners desire to utilize for its
operational and capital expenses money earmarked for the payment of taxes may be a
practical business option but it is not a fundamental right which can be demanded from
the court or from the government.
NO VIOLATION OF EQUAL
PROTECTION
Petitioner claims that the revenue regulations are violative of the equal protection clause
because the CWT is being levied only on real estate enterprises. Specifically, petitioner
points out that manufacturing enterprises are not similarly imposed a CWT on their
sales, even if their manner of doing business is not much different from that of a real
estate enterprise. Like a manufacturing concern, a real estate business is involved in a
continuous process of production and it incurs costs and expenditures on a regular
basis. The only difference is that goods produced by the real estate business are house
and lot units.[84]
Again, we disagree.
The equal protection clause under the Constitution means that no person or
class of persons shall be deprived of the same protection of laws which is enjoyed by
other persons or other classes in the same place and in like circumstances.[85] Stated
differently, all persons belonging to the same class shall be taxed alike. It follows that the
guaranty of the equal protection of the laws is not violated by legislation based on a
reasonable classification. Classification, to be valid, must (1) rest on substantial
distinctions; (2) be germane to the purpose of the law; (3) not be limited to existing
conditions only and (4) apply equally to all members of the same class.[86]
The taxing power has the authority to make reasonable classifications for purposes of
taxation.[87] Inequalities which result from a singling out of one particular class for
taxation, or exemption, infringe no constitutional limitation.[88] The real estate industry
is, by itself, a class and can be validly treated differently from other business enterprises.
Petitioner, in insisting that its industry should be treated similarly as manufacturing
enterprises, fails to realize that what distinguishes the real estate business from other
manufacturing enterprises, for purposes of the imposition of the CWT, is not their
production processes but the prices of their goods sold and the number of transactions
involved. The income from the sale of a real property is bigger and its frequency of
transaction limited, making it less cumbersome for the parties to comply with the
withholding tax scheme.
On the other hand, each manufacturing enterprise may have tens of thousands of
transactions with several thousand customers every month involving both minimal and
substantial amounts. To require the customers of manufacturing enterprises, at present,
to withhold the taxes on each of their transactions with their tens or hundreds of
suppliers may result in an inefficient and unmanageable system of taxation and may well
defeat the purpose of the withholding tax system.
Petitioner counters that there are other businesses wherein expensive items are also
sold infrequently, e.g. heavy equipment, jewelry, furniture, appliance and other capital
goods yet these are not similarly subjected to the CWT.[89] As already discussed, the
Secretary may adopt any reasonable method to carry out its functions.[90] Under Section
57(B), it may choose what to subject to CWT.
A reading of Section 2.57.2 (M) of RR 2-98 will also show that petitioners argument is not
accurate. The sales of manufacturers who have clients within the top 5,000 corporations,
as specified by the BIR, are also subject to CWT for their transactions with said 5,000
corporations.[91]
SECTION 2.58.2 OF
RR NO. 2-98
MERELY
IMPLEMENTS
SECTION 58 OF RA
8424
Lastly, petitioner assails Section 2.58.2 of RR 2-98, which provides that the
Registry of Deeds should not effect the regisration of any document transferring real
property unless a certification is issued by the CIR that the withholding tax has been
paid. Petitioner proffers hardly any reason to strike down this rule except to rely on its
contention that the CWT is unconstitutional. We have ruled that it is not. Furthermore,
this provision uses almost exactly the same wording as Section 58(E) of RA 8424 and is
unquestionably in accordance with it:
Sec. 58. Returns and Payment of Taxes Withheld at Source.
(E) Registration with Register of Deeds. - No registration of any
document transferring real property shall be effected by the
Register of Deeds unless the [CIR] or his duly authorized
representative has certified that such transfer has been
reported, and the capital gains or [CWT], if any, has been
paid: xxxx any violation of this provision by the Register of Deeds
shall be subject to the penalties imposed under Section 269 of this
Code. (Emphasis supplied)
CONCLUSION
The renowned genius Albert Einstein was once quoted as saying [the] hardest thing in
the world to understand is the income tax.[92] When a party questions the
constitutionality of an income tax measure, it has to contend not only with Einsteins
observation but also with the vast and well-established jurisprudence in support of the
plenary powers of Congress to impose taxes. Petitioner has miserably failed to discharge
its burden of convincing the Court that the imposition of MCIT and CWT is
unconstitutional.
WHEREFORE, the petition is hereby DISMISSED.

Costs against petitioner.

SO ORDERED.
COMMISSIONER OF INTERNAL REVENUE, G.R. No. 180066 transport services for the carriage of passengers, mail, and property by air, in and
Petitioner, between any and all points and places throughout the Philippines, and between the
Present: Philippines and other countries.[5]
YNARES-SANTIAGO, J.,
Chairperson, For its fiscal year ending 31 March 2001 (FY 2000-2001), PAL allegedly incurred zero
CHICO-NAZARIO, taxable income,[6] which left it with unapplied creditable withholding tax[7] in the amount
- versus - VELASCO, JR., of P2,334,377.95. PAL did not pay any MCIT for the period.
NACHURA, and
PERALTA, JJ. In a letter dated 12 July 2002, addressed to petitioner Commissioner of Internal Revenue
(CIR), PAL requested for the refund of its unapplied creditable withholding tax for FY
Promulgated: 2000-2001. PAL attached to its letter the following: (1) Schedule of Creditable Tax
PHILIPPINE AIRLINES, INC., Withheld at Source for FY 2000-2001; (2) Certificates of Creditable Taxes Withheld; and
Respondent. _____________________ (3) Audited Financial Statements.

Acting on the aforementioned letter of PAL, the Large Taxpayers Audit and
Investigation Division 1 (LTAID 1) of the BIR Large Taxpayers Service (LTS), issued on
16 August 2002, Tax Verification Notice No. 00201448, authorizing Revenue Officer
Jacinto Cueto, Jr. (Cueto) to verify the supporting documents and pertinent records
relative to the claim of PAL for refund of its unapplied creditable withholding tax for FY
x- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -x 2000-20001. In a letter dated 19 August 2003, LTAID 1 Chief Armit S. Linsangan invited
PAL to an informal conference at the BIR National Office in Diliman, Quezon City, on 27
August 2003, at 10:00 a.m., to discuss the results of the investigation conducted by
DECISION Revenue Officer Cueto, supervised by Revenue Officer Madelyn T. Sacluti.

BIR officers and PAL representatives attended the scheduled informal

CHICO-NAZARIO, J.: conference, during which the former relayed to the latter that the BIR was denying the
claim for refund of PAL and, instead, was assessing PAL for deficiency MCIT for FY 2000-
2001. The PAL representatives argued that PAL was not liable for MCIT under its
Before this Court is a Petition for Review on Certiorari, under Rule 45 of the Revised franchise.The BIR officers then informed the PAL representatives that the matter would
Rules of Court, seeking the reversal and setting aside of the Decision[1] dated 9 August be referred to the BIR Legal Service for opinion.
2007 and Resolution[2] dated 11 October 2007 of the Court of Tax Appeals (CTA) en
banc in CTA E.B. No. 246. The CTA en banc affirmed the Decision[3] dated 31 July 2006 of The LTAID 1 issued, on 3 September 2003, PAN No. INC FY-3-31-01-000094,
the CTA Second Division in C.T.A. Case No. 7010, ordering the cancellation and which was received by PAL on 23 October 2003. LTAID 1 assessed PAL
withdrawal of Preliminary Assessment Notice (PAN) No. INC FY-3-31-01-000094 dated 3 for P262,474,732.54, representing deficiency MCIT for FY 2000-2001, plus interest and
September 2003 and Formal Letter of Demand dated 12 January 2004, issued by the compromise penalty, computed as follows:
Bureau of Internal Revenue (BIR) against respondent Philippine Airlines, Inc. (PAL), for
the payment of Minimum Corporate Income Tax (MCIT) in the amount Sales/Revenues from Operation P 38,798,721,685.00
of P272,421,886.58. Less: Cost of Services 30,316,679,013.00
Gross Income from Operation 8,482,042,672.00
There is no dispute as to the antecedent facts of this case. Add: Non-operating income 465,111,368.00
Total Gross Income for MCIT purposes 9,947,154,040.00[8]
PAL is a domestic corporation organized under the corporate laws of the Republic of the
Rate of Tax 2%
Philippines; declared the national flag carrier of the country; and the grantee under
Tax Due 178,943,080.80
Presidential Decree No. 1590[4] of a franchise to establish, operate, and maintain
Add: 20% interest (8-16-00 to 10-31-03) 83,506,651.74
 Compromise Penalty 25,000.00
Total Amount Due P 262,474,732.54[9]
In a Resolution dated 2 January 2007, the CTA Second Division denied the
Motion for Reconsideration of the CIR.
PAL protested PAN No. INC FY-3-31-01-000094 through a letter dated 4 November It was then the turn of the CIR to file a Petition for Review with the CTA en banc,
2003 to the BIR LTS. docketed as C.T.A. E.B. No. 246. The CTA en banc found that the cited legal provisions and
jurisprudence are teeming with life with respect to the grant of tax exemption too vivid
On 12 January 2004, the LTAID 1 sent PAL a Formal Letter of Demand for deficiency to pass unnoticed, and that the Court in Division correctly ruled in favor of the
MCIT for FY 2000-2001 in the amount of P271,421,88658, based on the following respondent [PAL] granting its petition for the cancellation of Assessment Notice No. INC
calculation: FY-3-31-01-000094 and Formal Letter of Demand for the deficiency MCIT in the amount
of P272,421,886.58.[12] Consequently, the CTA en banc denied the Petition of the CIR for
Sales/Revenues from Operation lack of merit. The CTA en banc likewise denied the Motion for Reconsideration of the CIR
P 38,798,721,685.00
Less: Cost of Services in a Resolution dated 11 October 2007.
Direct Costs - P 30,749,761,017.00
Less: Non-deductible Hence, the CIR comes before this Court via the instant Petition for Review on Certiorari,
interest expense 433,082,004.00 based on the grounds stated hereunder:
30,316,679,013.00
Gross Income from Operation P 8,482,042,672.00
Add: Non-operating Income 465,111,368.00THE COURT OF TAX APPEALS ERRED ON A QUESTION OF LAW IN ITS
Total Gross Income for MCIT purposes P 9,947,154,040.00ASSAILED DECISION BECAUSE:
MCIT tax due P 178,943,080.80
(1) [PAL] CLEARLY OPTED TO BE COVERED BY THE INCOME TAX
Interest 20% per annum 7/16/01 to 02/15/04 92,453,805.78
PROVISION OF THE NATIONAL INTERNAL REVENUE CODE OF 1997
Compromise Penalty 25,000.00
(NIRC OF 1997). (sic) AS AMENDED; HENCE, IT IS COVERED BY THE
Total MCIT due and demandable P 271,421,886.58[10]
MCIT PROVISION OF THE SAME CODE.

(2) THE MCIT DOES NOT BELONG TO THE CATEGORY OF OTHER

PAL received the foregoing Formal Letter of Demand on 12 February 2004,
TAXES WHICH WOULD ENABLE RESPONDENT TO AVAIL ITSELF OF
prompting it to file with the BIR LTS a formal written protest dated 13 February 2004.
THE IN LIEU (sic) OF ALL OTHER TAXES CLAUSE UNDER SECTION 13
OF P.D. NO. 1590 (CHARTER).
The BIR LTS rendered on 7 May 2004 its Final Decision on Disputed
Assessment, which was received by PAL on 26 May 2004. Invoking Revenue
(3) THE MCIT PROVISION OF THE NIRC OF 1997 IS NOT AN
Memorandum Circular (RMC) No. 66-2003, the BIR LTS denied with finality the protest
AMENDMENT OF [PALS] CHARTER.
of PAL and reiterated the request that PAL immediately pay its deficiency MCIT for FY
2000-2001, inclusive of penalties incident to delinquency.
(4) PAL IS NOT ONLY GIVEN THE PRIVILEGE TO CHOOSE BETWEEN
WHAT WILL GIVE IT THE BENEFIT OF A LOWER TAX, BUT ALSO THE
PAL filed a Petition for Review with the CTA, which was docketed as C.T.A. Case No. 7010
RESPONSIBILITY OF PAYING ITS SHARE OF THE TAX BURDEN, AS IS
and raffled to the CTA Second Division. The CTA Second Division promulgated its
EVIDENT IN SECTION 22 OF RA NO. 9337.
Decision on 31 July 2006, ruling in favor of PAL. The dispositive portion of the judgment
of the CTA Second Division reads:
(5) A CLAIM FOR EXEMPTION FROM TAXATION IS NEVER
PRESUMED; [PAL] IS LIABLE FOR THE DEFICIENCY MCIT.[13]
WHEREFORE, premises considered, the instant Petition for
Review is hereby GRANTED. Accordingly, Assessment Notice No. INC
FY-3-31-01-000094 and Formal Letter of Demand for the payment of
There is only one vital issue that the Court must resolve in the Petition at bar, i.e.,
deficiency Minimum Corporate Income Tax in the amount
whether PAL is liable for deficiency MCIT for FY 2000-2001.
of P272,421,886.58 are hereby CANCELLED and WITHDRAWN.[11]

The Court answers in the negative.
Presidential Decree No. 1590, the franchise of PAL, contains provisions specifically
governing the taxation of said corporation, to wit:
Section 13. In consideration of the franchise and rights
hereby granted, the grantee shall pay to the Philippine Government
during the life of this franchise whichever of subsections (a) and
(b) hereunder will result in a lower tax:
(a) The basic corporate income tax based on the grantee's
annual net taxable income computed in accordance with the
provisions of the National Internal Revenue Code; or
(b) A franchise tax of two per cent (2%) of the gross
revenues derived by the grantee from all sources, without distinction
as to transport or nontransport operations; provided, that with
respect to international air-transport service, only the gross
passenger, mail, and freight revenues from its outgoing flights shall be
subject to this tax.
The tax paid by the grantee under either of the above
alternatives shall be in lieu of all other taxes, duties, royalties,
registration, license, and other fees and charges of any kind, nature, or
description, imposed, levied, established, assessed, or collected by any
municipal, city, provincial, or national authority or government
agency, now or in the future, including but not limited to the
following:
1. All taxes, duties, charges, royalties, or fees due on local
purchases by the grantee of aviation gas, fuel, and oil, whether refined
or in crude form, and whether such taxes, duties, charges, royalties, or
fees are directly due from or imposable upon the purchaser or the
seller, producer, manufacturer, or importer of said petroleum
products but are billed or passed on to the grantee either as part of
the price or cost thereof or by mutual agreement or other
arrangement; provided, that all such purchases by, sales or deliveries
of aviation gas, fuel, and oil to the grantee shall be for exclusive use in
its transport and nontransport operations and other activities
incidental thereto;
2. All taxes, including compensating taxes, duties, charges,
royalties, or fees due on all importations by the grantee of aircraft,
engines, equipment, machinery, spare parts, accessories, commissary
and catering supplies, aviation gas, fuel, and oil, whether refined or in
crude form and other articles, supplies, or materials; provided, that
such articles or supplies or materials are imported for the use of the
grantee in its transport and nontransport operations and other
activities incidental thereto and are not locally available in reasonable
quantity, quality, or price;
3. All taxes on lease rentals, interest, fees, and other charges
payable to lessors, whether foreign or domestic, of aircraft, engines,
equipment, machinery, spare parts, and other property rented, leased,
or chartered by the grantee where the payment of such taxes is
assumed by the grantee;
4. All taxes on interest, fees, and other charges on foreign
loans obtained and other obligations incurred by the grantee where
the payment of such taxes is assumed by the grantee;
5. All taxes, fees, and other charges on the registration,
licensing, acquisition, and transfer of aircraft, equipment, motor
vehicles, and all other personal and real property of the grantee; and
6. The corporate development tax under Presidential Decree
No. 1158-A.
The grantee, shall, however, pay the tax on its real
property in conformity with existing law.
For purposes of computing the basic corporate income
tax as provided herein, the grantee is authorized:
(a) To depreciate its assets to the extent of not more
than twice as fast the normal rate of depreciation; and
(b) To carry over as a deduction from taxable income
any net loss incurred in any year up to five years following the year of
such loss.
Section 14. The grantee shall pay either the franchise tax or
the basic corporate income tax on quarterly basis to the
Commissioner of Internal Revenue. Within sixty (60) days after the
end of each of the first three quarters of the taxable calendar or fiscal
year, the quarterly franchise or income-tax return shall be filed and
payment of either the franchise or income tax shall be made by the
grantee.
A final or an adjustment return covering the operation of the
grantee for the preceding calendar or fiscal year shall be filed on or
before the fifteenth day of the fourth month following the close of the
calendar or fiscal year. The amount of the final franchise or income tax
to be paid by the grantee shall be the balance of the total franchise or
 income tax shown in the final or adjustment return after deducting
therefrom the total quarterly franchise or income taxes already paid
during the preceding first three quarters of the same taxable year.
Any excess of the total quarterly payments over the actual
annual franchise of income tax due as shown in the final or
adjustment franchise or income-tax return shall either be refunded to
the grantee or credited against the grantee's quarterly franchise or
income-tax liability for the succeeding taxable year or years at the
option of the grantee.
The term "gross revenues" is herein defined as the total
gross income earned by the grantee from; (a) transport, nontransport,
and other services; (b) earnings realized from investments in money-
market placements, bank deposits, investments in shares of stock and
other securities, and other investments; (c) total gains net of total
losses realized from the disposition of assets and foreign-exchange
transactions; and (d) gross income from other sources. (Emphases
ours.)
According to the afore-quoted provisions, the taxation of PAL, during the lifetime of its
franchise, shall be governed by two fundamental rules, particularly: (1) PAL shall pay the
Government either basic corporate income tax or franchise tax, whichever is lower; and
(2) the tax paid by PAL, under either of these alternatives, shall be in lieu of all other
taxes, duties, royalties, registration, license, and other fees and charges, except only real
property tax.
The basic corporate income tax of PAL shall be based on its annual net taxable
income, computed in accordance with the National Internal Revenue Code
(NIRC).Presidential Decree No. 1590 also explicitly authorizes PAL, in the computation of
its basic corporate income tax, to (1) depreciate its assets twice as fast the normal rate of
depreciation;[14] and (2) carry over as a deduction from taxable income any net loss
incurred in any year up to five years following the year of such loss.[15]
Franchise tax, on the other hand, shall be two per cent (2%) of the gross revenues
derived by PAL from all sources, whether transport or nontransport
operations. However, with respect to international air-transport service, the franchise
tax shall only be imposed on the gross passenger, mail, and freight revenues of PAL from
its outgoing flights.
In its income tax return for FY 2000-2001, filed with the BIR, PAL reported no net
taxable income for the period, resulting in zero basic corporate income tax, which would
necessarily be lower than any franchise tax due from PAL for the same period.
The CIR, though, assessed PAL for MCIT for FY 2000-2001. It is the position of the CIR
that the MCIT is income tax for which PAL is liable. The CIR reasons that Section 13(a) of
Presidential Decree No. 1590 provides that the corporate income tax of PAL shall be
computed in accordance with the NIRC. And, since the NIRC of 1997 imposes MCIT, and
PAL has not applied for relief from the said tax, then PAL is subject to the same.
The Court is not persuaded. The arguments of the CIR are contrary to the plain meaning
and obvious intent of Presidential Decree No. 1590, the franchise of PAL.
Income tax on domestic corporations is covered by Section 27 of the NIRC of
1997,[16] pertinent provisions of which are reproduced below for easy reference:
SEC. 27. Rates of Income Tax on Domestic Corporations.
(A) In General Except as otherwise provided in this Code, an
income tax of thirty-five percent (35%) is hereby imposed upon
the taxable income derived during each taxable year from all sources
within and without the Philippines by every corporation, as defined in
Section 22(B) of this Code and taxable under this Title as a
corporation, organized in, or existing under the laws of the
Philippines: Provided, That effective January 1, 1998, the rate of
income tax shall be thirty-four percent (34%); effective January 1,
1999, the rate shall be thirty-three percent (33%); and effective
January 1, 2000 and thereafter, the rate shall be thirty-two percent
(32%).
xxxx
(E) Minimum Corporate Income Tax on Domestic
Corporations.
(1) Imposition of Tax. A minimum corporate income tax
of two percent (2%) of the gross income as of the end of the taxable
year, as defined herein, is hereby imposed on a corporation taxable
under this Title, beginning on the fourth taxable year immediately
following the year in which such corporation commenced its business
operations, when the minimum income tax is greater than the tax
computed under Subsection (A) of this Section for the taxable year.
Hence, a domestic corporation must pay whichever is higher of: (1) the income tax under
Section 27(A) of the NIRC of 1997, computed by applying the tax rate therein to the
taxable income of the corporation; or (2) the MCIT under Section 27(E), also of the NIRC
of 1997, equivalent to 2% of the gross income of the corporation. Although this may be
the general rule in determining the income tax due from a domestic corporation under
the NIRC of 1997, it can only be applied to PAL to the extent allowed by the provisions in
the franchise of PAL specifically governing its taxation.
After a conscientious study of Section 13 of Presidential Decree No. 1590, in relation to
Sections 27(A) and 27(E) of the NIRC of 1997, the Court, like the CTA en banc and Second
Division, concludes that PAL cannot be subjected to MCIT for FY 2000-2001.
First, Section 13(a) of Presidential Decree No. 1590 refers to basic corporate income
tax. In Commissioner of Internal Revenue v. Philippine Airlines, Inc.,[17] the Court already
settled that the basic corporate income tax, under Section 13(a) of Presidential Decree
No. 1590, relates to the general rate of 35% (reduced to 32% by the year 2000) as
stipulated in Section 27(A) of the NIRC of 1997.
Section 13(a) of Presidential Decree No. 1590 requires that the basic corporate income
tax be computed in accordance with the NIRC. This means that PAL shall compute its
basic corporate income tax using the rate and basis prescribed by the NIRC of 1997 for
the said tax. There is nothing in Section 13(a) of Presidential Decree No. 1590 to support
the contention of the CIR that PAL is subject to the entire Title II of the NIRC of 1997,
entitled Tax on Income.
Second, Section 13(a) of Presidential Decree No. 1590 further provides that the basic
corporate income tax of PAL shall be based on its annual net taxable income. This is
consistent with Section 27(A) of the NIRC of 1997, which provides that the rate of basic
corporate income tax, which is 32% beginning 1 January 2000, shall be imposed on
the taxable income of the domestic corporation.
Taxable income is defined under Section 31 of the NIRC of 1997 as the pertinent items
of gross income specified in the said Code, less the deductions and/or personal and
additional exemptions, if any, authorized for such types of income by the same
Code or other special laws. The gross income, referred to in Section 31, is described in
Section 32 of the NIRC of 1997 as income from whatever source, including compensation
for services; the conduct of trade or business or the exercise of profession; dealings in
property; interests; rents; royalties; dividends; annuities; prizes and winnings; pensions;
and a partners distributive share in the net income of a general professional partnership.
Pursuant to the NIRC of 1997, the taxable income of a domestic corporation may be
arrived at by subtracting from gross income deductions authorized, not just by the NIRC
of 1997,[18] but also by special laws. Presidential Decree No. 1590 may be considered as
one of such special laws authorizing PAL, in computing its annual net taxable income, on
which its basic corporate income tax shall be based, to deduct from its gross income the
following: (1) depreciation of assets at twice the normal rate; and (2) net loss carry-over
up to five years following the year of such loss.
In comparison, the 2% MCIT under Section 27(E) of the NIRC of 1997 shall be based on
the gross income of the domestic corporation. The Court notes that gross income, as the
basis for MCIT, is given a special definition under Section 27(E)(4) of the NIRC of 1997,
different from the general one under Section 34 of the same Code.
According to the last paragraph of Section 27(E)(4) of the NIRC of 1997, gross income of
a domestic corporation engaged in the sale of service means gross receipts, less sales
returns, allowances, discounts and cost of services. Cost of services refers to
all direct costs and expenses necessarily incurred to provide the services required by
the customers and clients including (a) salaries and employee benefits of personnel,
consultants, and specialists directly rendering the service; and (b) cost of facilities
directly utilized in providing the service, such as depreciation or rental of equipment
used and cost of supplies.[19] Noticeably, inclusions in and exclusions/deductions from
gross income for MCIT purposes are limited to those directly arising from the conduct of
the taxpayers business. It is, thus, more limited than the gross income used in the
computation of basic corporate income tax.
In light of the foregoing, there is an apparent distinction under the NIRC of 1997 between
taxable income, which is the basis for basic corporate income tax under Section 27(A);
and gross income, which is the basis for the MCIT under Section 27(E). The two terms
have their respective technical meanings, and cannot be used interchangeably.The same
reasons prevent this Court from declaring that the basic corporate income tax, for which
PAL is liable under Section 13(a) of Presidential Decree No. 1590, also covers MCIT
under Section 27(E) of the NIRC of 1997, since the basis for the first is the annual net
taxable income, while the basis for the second is gross income.
Third, even if the basic corporate income tax and the MCIT are both income taxes under
Section 27 of the NIRC of 1997, and one is paid in place of the other, the two are distinct
and separate taxes.
The Court again cites Commissioner of Internal Revenue v. Philippine Airlines,
Inc.,[20] wherein it held that income tax on the passive income [21] of a domestic
corporation, under Section 27(D) of the NIRC of 1997, is different from the basic
corporate income tax on the taxable income of a domestic corporation, imposed by
Section 27(A), also of the NIRC of 1997. Section 13 of Presidential Decree No. 1590 gives
PAL the option to pay basic corporate income tax or franchise tax, whichever is lower;
and the tax so paid shall be in lieu of all other taxes, except real property tax. The income
tax on the passive income of PAL falls within the category of all other taxes from which
PAL is exempted, and which, if already collected, should be refunded to PAL.
The Court herein treats MCIT in much the same way. Although both are income taxes, the
MCIT is different from the basic corporate income tax, not just in the rates, but also in the
bases for their computation. Not being covered by Section 13(a) of Presidential Decree
No. 1590, which makes PAL liable only for basic corporate income tax, then MCIT is
included in all other taxes from which PAL is exempted.
That, under general circumstances, the MCIT is paid in place of the basic corporate
income tax, when the former is higher than the latter, does not mean that these two
income taxes are one and the same. The said taxes are merely paid in the alternative,
giving the Government the opportunity to collect the higher amount between the
two. The situation is not much different from Section 13 of Presidential Decree No. 1590,
which reversely allows PAL to pay, whichever is lower of the basic corporate income tax
or the franchise tax. It does not make the basic corporate income tax indistinguishable
from the franchise tax.
Given the fundamental differences between the basic corporate income tax and the MCIT,
presented in the preceding discussion, it is not baseless for this Court to rule that,
pursuant to the franchise of PAL, said corporation is subject to the first tax, yet exempted
from the second.
Fourth, the evident intent of Section 13 of Presidential Decree No. 1520 is to extend to
PAL tax concessions not ordinarily available to other domestic corporations. Section 13
of Presidential Decree No. 1520 permits PAL to pay whichever is lower of the basic
corporate income tax or the franchise tax; and the tax so paid shall be in lieu of all other
taxes, except only real property tax. Hence, under its franchise, PAL is to pay the least
amount of tax possible.
Section 13 of Presidential Decree No. 1520 is not unusual. A public utility is granted
special tax treatment (including tax exceptions/exemptions) under its franchise, as an
inducement for the acceptance of the franchise and the rendition of public service by the
said public utility.[22] In this case, in addition to being a public utility providing air-
transport service, PAL is also the official flag carrier of the country.
The imposition of MCIT on PAL, as the CIR insists, would result in a situation that
contravenes the objective of Section 13 of Presidential Decree No. 1590. In effect, PAL
would not just have two, but three tax alternatives, namely, the basic corporate income
tax, MCIT, or franchise tax. More troublesome is the fact that, as between the basic
corporate income tax and the MCIT, PAL shall be made to pay whichever is higher,
irrefragably, in violation of the avowed intention of Section 13 of Presidential Decree No.
1590 to make PAL pay for the lower amount of tax.
Fifth, the CIR posits that PAL may not invoke in the instant case the in lieu of all other
taxes clause in Section 13 of Presidential Decree No. 1520, if it did not pay anything at all
as basic corporate income tax or franchise tax. As a result, PAL should be made liable for
other taxes such as MCIT. This line of reasoning has been dubbed as the Substitution
Theory, and this is not the first time the CIR raised the same. The Court already rejected
the Substitution Theory in Commissioner of Internal Revenue v. Philippine Airlines,
Inc.,[23] to wit:
Substitution Theory
of the CIR Untenable
A careful reading of Section 13 rebuts the argument of
the CIR that the in lieu of all other taxes proviso is a mere
incentive that applies only when PAL actually pays something. It
is clear that PD 1590 intended to give respondent the option to avail
itself of Subsection (a) or (b) as consideration for its franchise. Either
option excludes the payment of other taxes and dues imposed or
collected by the national or the local government. PAL has the option
to choose the alternative that results in lower taxes. It is not the fact
of tax payment that exempts it, but the exercise of its option.
Under Subsection (a), the basis for the tax rate is
respondents annual net taxable income, which (as earlier discussed)
is computed by subtracting allowable deductions and exemptions
from gross income. By basing the tax rate on the annual net taxable
income, PD 1590 necessarily recognized the situation in which taxable
income may result in a negative amount and thus translate into a zero
tax liability.
Notably, PAL was owned and operated by the government at
the time the franchise was last amended. It can reasonably be
contemplated that PD 1590 sought to assist the finances of the
government corporation in the form of lower taxes. When respondent
operates at a loss (as in the instant case), no taxes are due; in this
instances, it has a lower tax liability than that provided by Subsection
(b).
The fallacy of the CIRs argument is evident from the fact
that the payment of a measly sum of one peso would suffice to
exempt PAL from other taxes, whereas a zero liability arising
from its losses would not. There is no substantial distinction
between a zero tax and a one-peso tax liability. (Emphasis ours.)
Based on the same ratiocination, the Court finds the Substitution Theory
unacceptable in the present Petition.
The CIR alludes as well to Republic Act No. 9337, for reasons similar to those behind the
Substitution Theory. Section 22 of Republic Act No. 9337, more popularly known as the
Expanded Value Added Tax (E-VAT) Law, abolished the franchise tax imposed by the
charters of particularly identified public utilities, including Presidential Decree No. 1590
of PAL. PAL may no longer exercise its options or alternatives under Section 13 of
Presidential Decree No. 1590, and is now liable for both corporate income tax and the
12% VAT on its sale of services. The CIR alleges that Republic Act No. 9337 reveals the
intention of the Legislature to make PAL share the tax burden of other domestic
corporations.
The CIR seems to lose sight of the fact that the Petition at bar involves the liability of PAL
for MCIT for the fiscal year ending 31 March 2001. Republic Act No. 9337, which took
effect on 1 July 2005, cannot be applied retroactively[24] and any amendment introduced
by said statute affecting the taxation of PAL is immaterial in the present case.
And sixth, Presidential Decree No. 1590 explicitly allows PAL, in computing its basic
corporate income tax, to carry over as deduction any net loss incurred in any year, up to
five years following the year of such loss. Therefore, Presidential Decree No. 1590 does
not only consider the possibility that, at the end of a taxable period, PAL shall end up
with zero annual net taxable income (when its deductions exactly equal its gross
income), as what happened in the case at bar, but also the likelihood that PAL shall
incur net loss (when its deductions exceed its gross income). If PAL is subjected to MCIT,
the provision in Presidential Decree No. 1590 on net loss carry-over will be rendered
nugatory. Net loss carry-over is material only in computing the annual net taxable
income to be used as basis for the basic corporate income tax of PAL; but PAL will never
be able to avail itself of the basic corporate income tax option when it is in a net loss
position, because it will always then be compelled to pay the necessarily higher MCIT.
Consequently, the insistence of the CIR to subject PAL to MCIT cannot be done without
contravening Presidential Decree No. 1520.
Between Presidential Decree No. 1520, on one hand, which is a special law specifically
governing the franchise of PAL, issued on 11 June 1978; and the NIRC of 1997, on the
other, which is a general law on national internal revenue taxes, that took effect on 1
January 1998, the former prevails. The rule is that on a specific matter, the special law
shall prevail over the general law, which shall be resorted to only to supply deficiencies
in the former. In addition, where there are two statutes, the earlier special and the later
general the terms of the general broad enough to include the matter provided for in the
special the fact that one is special and the other is general creates a presumption that the
special is to be considered as remaining an exception to the general, one as a general law
of the land, the other as the law of a particular case. It is a canon of statutory
construction that a later statute, general in its terms and not expressly repealing a prior
special statute, will ordinarily not affect the special provisions of such earlier statute. [25]
Neither can it be said that the NIRC of 1997 repealed or amended Presidential Decree No.
1590.
While Section 16 of Presidential Decree No. 1590 provides that the franchise is granted
to PAL with the understanding that it shall be subject to amendment, alteration, or repeal
by competent authority when the public interest so requires, Section 24 of the same
Decree also states that the franchise or any portion thereof may only be modified,
amended, or repealed expressly by a special law or decree that shall specifically
modify, amend, or repeal said franchise or any portion thereof. No such special law or
decree exists herein.
The CIR cannot rely on Section 7(B) of Republic Act No. 8424, which amended the NIRC
in 1997 and reads as follows:
Section 7. Repealing Clauses.
xxxx
(B) The provisions of the National Internal Revenue Code, as
amended, and all other laws, including charters of government-
owned or controlled corporations, decrees, orders, or regulations
or parts thereof, that are inconsistent with this Act are hereby
repealed or amended accordingly.
The CIR reasons that PAL was a government-owned and controlled corporation when
Presidential Decree No. 1590, its franchise or charter, was issued in 1978. Since PAL was
still operating under the very same charter when Republic Act No. 8424 took effect in
1998, then the latter can repeal or amend the former by virtue of Section 7(B).
The Court disagrees.
A brief recount of the history of PAL is in order. PAL was established as a private
corporation under the general law of the Republic of the Philippines in February
1941. In November 1977, the government, through the Government Service Insurance
System (GSIS), acquired the majority shares in PAL. PAL was privatized in January
1992 when the local consortium PR Holdings acquired a 67% stake therein.[26]
It is true that when Presidential Decree No. 1590 was issued on 11 June 1978, PAL was
then a government-owned and controlled corporation; but when Republic Act No. 8424,
amending the NIRC, took effect on 1 January 1998, PAL was already a private
corporation for six years. The repealing clause under Section 7(B) of Republic Act No.
8424 simply refers to charters of government-owned and controlled corporations, which
would simply and plainly mean corporations under the ownership and control of the
government at the time of effectivity of said statute. It is already a stretch for the Court
to read into said provision charters, issued to what were then government-owned and
controlled corporations that are now private, but still operating under the same charters.
That the Legislature chose not to amend or repeal Presidential Decree No. 1590, even
after PAL was privatized, reveals the intent of the Legislature to let PAL continue
enjoying, as a private corporation, the very same rights and privileges under the terms
and conditions stated in said charter. From the moment PAL was privatized, it had to be
treated as a private corporation, and its charter became that of a private corporation. It
would be completely illogical to say that PAL is a private corporation still operating
under a charter of a government-owned and controlled corporation.
The alternative argument of the CIR that the imposition of the MCIT is pursuant to the
amendment of the NIRC, and not of Presidential Decree No. 1590 is just as specious.As
has already been settled by this Court, the basic corporate income tax under Section
13(a) of Presidential Decree No. 1590 relates to the general tax rate under Section 27(A)
of the NIRC of 1997, which is 32% by the year 2000, imposed on taxable income. Thus,
only provisions of the NIRC of 1997 necessary for the computation of the basic corporate
income tax apply to PAL. And even though Republic Act No. 8424 amended the NIRC by
introducing the MCIT, in what is now Section 27(E) of the said Code, this amendment is
actually irrelevant and should not affect the taxation of PAL, since the MCIT is clearly
distinct from the basic corporate income tax referred to in Section 13(a) of Presidential
Decree No. 1590, and from which PAL is consequently exempt under the in lieu of all
other taxes clause of its charter.
The CIR calls the attention of the Court to RMC No. 66-2003, on Clarifying the Taxability
of Philippine Airlines (PAL) for Income Tax Purposes As Well As Other Franchise
Grantees Similarly Situated. According to RMC No. 66-2003:
Section 27(E) of the Code, as implemented by Revenue
Regulations No. 9-98, provides that MCIT of two percent (2%) of the
gross income as of the end of the taxable year (whether calendar or
fiscal year, depending on the accounting period employed) is imposed
upon any domestic corporation beginning the 4th taxable year
immediately following the taxable year in which such corporation
commenced its business operations. The MCIT shall be imposed
whenever such corporation has zero or negative taxable income or
whenever the amount of MCIT is greater than the normal income tax
due from such corporation.
With the advent of such provision beginning January 1,
1998, it is certain that domestic corporations subject to normal
income tax as well as those choose to be subject thereto, such as PAL,
are bound to pay income tax regardless of whether they are operating
at a profit or loss.
Thus, in case of operating loss, PAL may either opt to subject
itself to minimum corporate income tax or to the 2% franchise tax,
whichever is lower. On the other hand, if PAL is operating at a profit,
the income tax liability shall be the lower amount between:
(1) normal income tax or MCIT whichever is higher; and
(2) 2% franchise tax.
The CIR attempts to sway this Court to adopt RMC No. 66-2003 since the [c]onstruction
by an executive branch of government of a particular law although not binding upon the
courts must be given weight as the construction comes from the branch of the
government called upon to implement the law.[27]
But the Court is unconvinced.
It is significant to note that RMC No. 66-2003 was issued only on 14 October 2003, more
than two years after FY 2000-2001 of PAL ended on 31 March 2001. This violates the
well-entrenched principle that statutes, including administrative rules and regulations,
operate prospectively only, unless the legislative intent to the contrary is manifest by
express terms or by necessary implication.[28]
Moreover, despite the claims of the CIR that RMC No. 66-2003 is just a clarificatory and
internal issuance, the Court observes that RMC No. 66-2003 does more than just clarify a
previous regulation and goes beyond mere internal administration. It effectively
increases the tax burden of PAL and other taxpayers who are similarly situated, making
them liable for a tax for which they were not liable before. Therefore, RMC No. 66-2003
cannot be given effect without previous notice or publication to those who will be
affected thereby. In Commissioner of Internal Revenue v. Court of Appeals,[29] the Court
ratiocinated that:
It should be understandable that when an administrative
rule is merely interpretative in nature, its applicability needs nothing
further than its bare issuance for it gives no real consequence more
than what the law itself has already prescribed. When, upon the
other hand, the administrative rule goes beyond merely
providing for the means that can facilitate or render least
cumbersome the implementation of the law but substantially
adds to or increases the burden of those governed, it behooves
the agency to accord at least to those directly affected a chance to
be heard, and thereafter to be duly informed, before that new
issuance is given the force and effect of law.
A reading of RMC 37-93, particularly considering the
circumstances under which it has been issued, convinces us that the
circular cannot be viewed simply as a corrective measure (revoking in
the process the previous holdings of past Commissioners) or merely
as construing Section 142(c)(1) of the NIRC, as amended, but has, in
fact and most importantly, been made in order to place "Hope
Luxury," "Premium More" and "Champion" within the classification of
locally manufactured cigarettes bearing foreign brands and to thereby
have them covered by RA 7654. Specifically, the new law would have
its amendatory provisions applied to locally manufactured cigarettes
which at the time of its effectivity were not so classified as bearing
foreign brands. Prior to the issuance of the questioned circular, "Hope
Luxury," "Premium More," and "Champion" cigarettes were in the
category of locally manufactured cigarettes not bearing foreign brand
subject to 45% ad valorem tax. Hence, without RMC 37-93, the
enactment of RA 7654, would have had no new tax rate consequence
on private respondent's products. Evidently, in order to place "Hope
Luxury," "Premium More," and "Champion" cigarettes within the
scope of the amendatory law and subject them to an increased tax
rate, the now disputed RMC 37-93 had to be issued. In so doing, the
BIR not simply interpreted the law; verily, it legislated under its
quasi-legislative authority. The due observance of the
requirements of notice, of hearing, and of publication should not
have been then ignored.
Indeed, the BIR itself, in its RMC 10-86, has observed and
provided:
"RMC NO. 10-86
Effectivity of Internal Revenue Rules and
Regulations "It has been observed that one of the
problem areas bearing on compliance with Internal
Revenue Tax rules and regulations is lack or
insufficiency of due notice to the tax paying
public. Unless there is due notice, due
compliance therewith may not be reasonably
expected. And most importantly, their strict
enforcement could possibly suffer from legal
infirmity in the light of the constitutional provision
on 'due process of law' and the essence of the Civil
Code provision concerning effectivity of laws,
whereby due notice is a basic requirement (Sec. 1,
Art. IV, Constitution; Art. 2, New Civil Code).
"In order that there shall be a just
enforcement of rules and regulations, in
conformity with the basic element of due
process, the following procedures are hereby
prescribed for the drafting, issuance and
implementation of the said Revenue Tax Issuances:
"(1).
This Circular shall apply only to (a) Revenue
Regulations; (b) Revenue Audit Memorandum
Orders; and (c) Revenue Memorandum
Circulars and Revenue Memorandum Orders
bearing on internal revenue tax rules and
regulations.
"(2). Except when the law otherwise
expressly provides, the aforesaid internal revenue
tax issuances shall not begin to be operative
until after due notice thereof may be fairly
presumed.
"Due notice of the said issuances may be
fairly presumed only after the following
procedures have been taken:
"xxx xxx xxx "(5). Strict compliance with
the foregoing procedures is enjoined.13
Nothing on record could tell us that it was either impossible
or impracticable for the BIR to observe and comply with the above
requirements before giving effect to its questioned circular.
(Emphases ours.)
The Court, however, stops short of ruling on the validity of RMC No. 66-2003, for it is not
among the issues raised in the instant Petition. It only wishes to stress the requirement
of prior notice to PAL before RMC No. 66-2003 could have become effective. Only after
RMC No. 66-2003 was issued on 14 October 2003 could PAL have been given notice of
said circular, and only following such notice to PAL would RMC No. 66-2003 have taken
effect. Given this sequence, it is not possible to say that RMC No. 66-2003 was already in
effect and should have been strictly complied with by PAL for its fiscal year which ended
on 31 March 2001.
Even conceding that the construction of a statute by the CIR is to be given great weight,
the courts, which include the CTA, are not bound thereby if such construction is
erroneous or is clearly shown to be in conflict with the governing statute or the
Constitution or other laws. "It is the role of the Judiciary to refine and, when necessary,
correct constitutional (and/or statutory) interpretation, in the context of the interactions
of the three branches of the government."[30] It is furthermore the rule of long standing
that this Court will not set aside lightly the conclusions reached by the CTA which, by the
very nature of its functions, is dedicated exclusively to the resolution of tax problems and
has, accordingly, developed an expertise on the subject, unless there has been an abuse
or improvident exercise of authority.[31] In the Petition at bar, the CTA en banc and in
division both adjudged that PAL is not liable for MCIT under Presidential Decree No.
1590, and this Court has no sufficient basis to reverse them.
As to the assertions of the CIR that exemption from tax is not presumed, and the one Not being liable for MCIT in FY 2000-2001, it necessarily follows that PAL need not apply
claiming it must be able to show that it indubitably exists, the Court recalls its for relief from said tax as the CIR maintains.
pronouncements in Commissioner of Internal Revenue v. Court of Appeals[32]:
We disagree. Petitioner Commissioner of Internal Revenue erred in WHEREFORE, premises considered, the instant Petition for Review is
applying the principles of tax exemption without first applying the hereby DENIED, and the Decision dated 9 August 2007 and Resolution dated 11 October
well-settled doctrine of strict interpretation in the imposition of 2007 of the Court of Tax Appeals en banc in CTA E.B. No. 246 is hereby AFFIRMED. No
taxes. It is obviously both illogical and impractical to determine costs.
who are exempted without first determining who are covered by
the aforesaid provision. The Commissioner should have determined SO ORDERED.
first if private respondent was covered by Section 205, applying the
rule of strict interpretation of laws imposing taxes and other burdens
on the populace, before asking Ateneo to prove its exemption
therefrom. The Court takes this occasion to reiterate the hornbook
doctrine in the interpretation of tax laws that (a) statute will not be
construed as imposing a tax unless it does so clearly, expressly, and
unambiguously. x x x (A) tax cannot be imposed without clear and
express words for that purpose. Accordingly, the general rule of
requiring adherence to the letter in construing statutes applies
with peculiar strictness to tax laws and the provisions of a taxing
act are not to be extended by implication. Parenthetically, in
answering the question of who is subject to tax statutes, it is
basic that in case of doubt, such statutes are to be construed most
strongly against the government and in favor of the subjects or
citizens because burdens are not to be imposed nor presumed to
be imposed beyond what statutes expressly and clearly
import.(Emphases ours.)

For two decades following the grant of its franchise by Presidential Decree No. 1590 in
1978, PAL was only being held liable for the basic corporate income tax or franchise tax,
whichever was lower; and its payment of either tax was in lieu of all other taxes, except
real property tax, in accordance with the plain language of Section 13 of the charter of
PAL. Therefore, the exemption of PAL from all other taxes was not just a presumption,
but a previously established, accepted, and respected fact, even for the BIR.

The MCIT was a new tax introduced by Republic Act No. 8424. Under the doctrine of
strict interpretation, the burden is upon the CIR to primarily prove that the new MCIT
provisions of the NIRC of 1997, clearly, expressly, and unambiguously extend and apply
to PAL, despite the latters existing tax exemption. To do this, the CIR must convince the
Court that the MCIT is a basic corporate income tax,[33] and is not covered by the in lieu
of all other taxes clause of Presidential Decree No. 1590. Since the CIR failed in this
regard, the Court is left with no choice but to consider the MCIT as one of all other taxes,
from which PAL is exempt under the explicit provisions of its charter.
[G.R. No. L-26145. February 20, 1984.]
THE MANILA WINE MERCHANTS, INC., Petitioner, v. THE COMMISSIONER OF
INTERNAL REVENUE, Respondent.
Rafael D. Salcedo for Petitioner.
The Solicitor General for Respondent.
SYLLABUS
1. TAXATION; NATIONAL INTERNAL REVENUE CODE; CORPORATE INCOME TAX;
ADDITIONAL TAX ON ACCUMULATED EARNINGS; EXEMPTION THEREFROM. — A
prerequisite to the imposition of the tax has been that the corporation be formed or
availed of for the purpose of avoiding the income tax (or surtax) on its shareholders, or
on the shareholders of any other corporation by permitting the earnings and profits of
the corporation to accumulate instead of dividing them among or distributing them to
the shareholders. If the earnings and profits were distributed, the shareholders would be
required to pay an income tax thereon whereas, if the distribution were not made to
them, they would incur no tax in respect to the undistributed earnings and profits of the
corporation (Mertens, Law on Federal Income Taxation, Vol. 7, Chapter 39, p. 44). The
touchstone of liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation (Ibid., p. 47). Thus, if the failure to pay dividends is
due to some other cause, such as the use of undistributed earnings and profits for the
reasonable needs of the business, such purpose does not fall within the interdiction of
the statute (Ibid., p. 45).
2. ID.; ID.; ID.; ID.; ID.; WHEN ACCUMULATION CONSIDERED UNREASONABLE. — An
accumulation of earnings or profits (including undistributed earnings or profits of prior
years) is unreasonable if it is not required for the purpose of the business, considering all
the circumstances of the case (Sec. 21, Revenue Regulations No. 2).
3. ID.; ID.; ID.; ID.; ID.; "REASONABLE NEEDS OF THE BUSINESS," CONSTRUED. — To
determine the "reasonable needs" of the business in order to justify an accumulation of
earnings, the Courts of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to mean the immediate
needs of the business, and it was generally held that if the corporation did not prove an
immediate need for the accumulation of the earnings and profits, the accumulation was
not for the reasonable needs of the business, and the penalty tax would apply. American
cases likewise hold that investment of the earnings and profits of the corporation in
stock or securities of an unrelated business usually indicates an accumulation beyond
the reasonable needs of the business. (Helvering v. Chicago Stockyards Co., 318 US 693;
Helvering v. National Grocery Co., 304 US 282).
4. REMEDIAL LAW; APPEALS; FACTUAL FINDINGS OF THE COURT OF TAX APPEALS,
BINDING. — The finding of the Court of Tax Appeals that the purchase of the U.S.A.
Treasury bonds were in no way related to petitioner’s business of importing and selling
wines whisky, liquors and distilled spirits, and thus construed as an investment beyond
the reasonable needs of the business is binding on Us, the same being factual (Renato
Raymundo v. Hon. De Jova, 101 SCRA 495). Furthermore, the wisdom behind thus
finding cannot be doubted, The case of J.M. Perry & Co. v. Commissioner of Internal
Revenue supports the same.
5. TAXATION; NATIONAL INTERNAL REVENUE CODE; INCOME TAX OF CORPORATIONS;
ADDITIONAL TAX ON ACCUMULATED EARNINGS; EXCEPTION THEREFROM;
ACCUMULATION OF EARNINGS, MUST BE USED FOR REASONABLE NEEDS OF BUSINESS
WITHIN A REASONABLE TIME. — The records further reveal that from May 1951 when
petitioner purchased the U.S.A. Treasury shares, until 1962 when it finally liquidated the
same, it (petitioner) never had the occasion to use the said shares in aiding or financing
its importation. This militates against the purpose enunciated earlier by petitioner that
the shares were purchased to finance its importation business. To justify an
accumulation of earnings and profits for the reasonably anticipated future needs, such
accumulation must be used within a reasonable time after the close of the taxable year
(Mertens, Ibid., p. 104).
6. ID.; ID.; ID.; ID.; ID.; ID.; INTENTION AT THE TIME OF ACCUMULATION, BASIS OF THE
TAX; ACCUMULATION OF PROFITS IN CASE AT BAR, UNREASONABLE. — In order to
determine whether profits are accumulated for the reasonable needs of the business as
to avoid the surtax upon shareholders, the controlling intention of the taxpayer is that
which is manifested at the time of accumulation not subsequently declared intentions
which are merely the product of afterthought (Basilan Estates, Inc. v. Comm. of Internal
Revenue, 21 SCRA 17 citing Jacob Mertens, Jr., The law of Federal Income Taxation, Vol.
7, Cumulative Supplement, p. 213; Smoot and San & Gravel Corp. v. Comm., 241 F 2d
197). A speculative and indefinite purpose will not suffice. The mere recognition of a
future problem and the discussion of possible and alternative solutions is not sufficient.
Definiteness of plan coupled with action taken towards its consummation are essential
(Fuel Carriers, Inc. v. US 202 F supp. 497; Smoot Sand & Gravel Corp. v. Comm., supra).
Viewed on the foregoing analysis and tested under the "immediacy doctrine," We are
convinced that the Court of Tax Appeals is correct in finding that the investment made by
petitioner in the U.S.A. Treasury shares in 1951 was an accumulation of profits in excess
of the reasonable needs of petitioner’s business.chanroblesvirtuallawlibrary
7. ID.; ID.; ID.; ID.; ACCUMULATIONS OF PRIOR YEARS TAKEN INTO ACCOUNT IN
DETERMINATION OF LIABILITY THEREFOR. — The rule is now settled in Our
jurisprudence that undistributed earnings or profits of prior years are taken into
consideration in determining unreasonable accumulation for purposes of the 25%
surtax. The case of Basilan Estates, Inc. v. Commissioner of Internal Revenue further —————
strengthen this rule in determining unreasonable accumulation for the year
concerned.’In determining whether accumulations of earnings or profits in a particular 25% surtax due thereon P107,234.00
year are within the reasonable needs of a corporation, it is necessary to take into account
prior accumulations, since accumulations prior to the year involved may have been Add: 1/2% monthly interest from June 20,
sufficient to cover the business needs and additional accumulations during the year
involved would not reasonably be necessary. 1959 to June 20, 1962 19,302.12

—————
DECISION
TOTAL AMOUNT DUE AND COLLECTIBLE P126,536.12

GUERRERO, J.: =========

In this Petition for Review on Certiorari, Petitioner, the Manila Wine Merchants, Inc.,
disputes the decision of the Court of Tax Appeals ordering it (petitioner) to pay
respondent, the Commissioner of Internal Revenue, the amount of P86,804.38 as 25%
surtax plus interest which represents the additional tax due petitioner for improperly
accumulating profits or surplus in the taxable year 1957 under Sec. 25 of the National
Internal Revenue Code.chanrobles virtualawlibrary chanrobles.com:chanrobles.com.ph
The Court of Tax Appeals made the following finding of facts, to
wit:jgc:chanrobles.com.ph
"Petitioner, a domestic corporation organized in 1937, is principally engaged in the
importation and sale of whisky, wines, liquors and distilled spirits. Its original subscribed
and paid capital was P500,000.00. Its capital of P500,000.00 was reduced to P250,000.00
in 1950 with the approval of the Securities and Exchange Commission but the reduction
of the capital was never implemented. On June 21, 1958, petitioner’s capital was
increased to P1,000,000.00 with the approval of the said Commission.
On December 31, 1957, herein respondent caused the examination of herein petitioner’s
book of account and found the latter of having unreasonably accumulated surplus of
P428,934.32 for the calendar year 1947 to 1957, in excess of the reasonable needs of the
business subject to the 25% surtax imposed by Section 25 of the Tax Code.
Respondent contends that petitioner has accumulated earnings beyond the reasonable
needs of its business because the average ratio of the cash dividends declared and paid
by petitioner from 1947 to 1957 was 40.33% of the total surplus available for
distribution at the end of each calendar year. On the other hand, petitioner contends that
in 1957, it distributed 100% of its net earnings after income tax and part of the surplus
for prior years. Respondent further submits that the accumulated earnings tax should be
based on 25% of the total surplus available at the end of each calendar year while
petitioner maintains that the 25% surtax is imposed on the total surplus or net income
for the year after deducting therefrom the income tax due.
The records show the following analysis of petitioner’s net income, cash dividends and
earned surplus for the years 1946 to 1957: 1
Percentage of
Dividends to
Net Income Total Cash Net Income Balance
After Income Dividends After of Earned
Year Tax Paid Income Tax Surplus

On February 26, 1963, the Commissioner of Internal Revenue demanded upon the 1946 P 613,790.00 P 200,000. 32.58% P 234,104.81
Manila Wine Merchants, Inc. payment of P126,536.12 as 25% surtax and interest on the
latter’s unreasonable accumulation of profits and surplus for the year 1957, computed as 1947 425,719.87 360,000. 84.56% 195,167.10
follows:chanrob1es virtual 1aw library
1948 415,591.83 375,000. 90.23% 272,991.38
Unreasonable accumulation of surtax P428,934.42
1949 335,058.06 200,000. 59.69% 893,113.42
1950 399,698.09 600,000. 150.11% 234,987.07 As to the investment of P27,501.00 made by petitioner in the Acme Commercial Co., Inc.,
Mr. N.R.E. Hawkins, president of the petitioner corporation 2 explained as
1951 346,257.26 300,000. 86.64% 281,244.33 follows:chanrob1es virtual 1aw library

1952 196,161.97 200,000. 101.96% 277,406.30 ‘The first item consists of shares of Acme Commercial Co., Inc. which the Company
acquired in 1947 and 1949. In the said years, we thought it prudent to invest in a
1953 169,714.04 200,000. 117.85% 301,138.84 business which patronizes us. As a supermarket, Acme Commercial Co., Inc. is one of our
best customers. The investment has proven to be beneficial to the stockholders of this
1954 238,124.85 250,000. 104.99% 289,262.69 Company. As an example, the Company received cash dividends in 1961 totalling
P16,875.00 which was included in its income tax return for the said year.’
1955 312,284.74 200,000. 64.04% 401,548.43
As to the investments of petitioner in Union Insurance Society of Canton and Wack Wack
1956 374,240.28 300,000. 80.16% 475,788.71 Golf Club in the sums of P1,145.76 and P1.00, respectively, the same official of the
petitioner-corporation stated that: 3
1957 353,145.71 400,000. 113.27% 428,934.42
‘The second and fourth items are small amounts which we believe would not affect this
—————— ————— ———— —————— case substantially. As regards the Union Insurance Society of Canton shares, this was a
pre-war investment, when Wise & Co., Inc., Manila Wine Merchants and the said
P4,179,787.36 P3,585.000. 85.77% P3,785.688.50 insurance firm were common stockholders of the Wise Bldg. Co.,, Inc. and the three
companies were all housed in the same building. Union Insurance invested in Wise Bldg.
========== ========= ======= ========== Co., Inc. but invited Manila Wine Merchants, Inc. to buy a few of its shares.’

Another basis of respondent in assessing petitioner for accumulated earnings tax is its As to the U.S.A. Treasury Bonds amounting to P347,217.50, Mr. Hawkins explained as
substantial investment of surplus or profits in unrelated business. These investments are follows: 4
itemized as follows:chanrob1es virtual 1aw library
‘With regards to the U.S.A. Treasury Bills in the amount of P347,217.50, in 1950, our
1. Acme Commercial Co., Inc. P 27,501.00 balance sheet for the said year shows the Company had deposited in current account in
various banks P629,403.64 which was not earning any interest. We decided to utilize
2. Union Insurance Society part of this money as reserve to finance our importations and to take care of future
expansion including acquisition of a lot and the construction of our own office building
of Canton 1,145.76 and bottling plant.

3. U.S.A. Treasury Bond 347,217.50 At that time, we believed that a dollar reserve abroad would be useful to the Company in
meeting immediate urgent orders of its local customers. In order that the money may
4. Wack Wack Golf & earn interest, the Company, on May 31, 1951 purchased US Treasury bills with 90-day
maturity and earning approximately 1% interest with the face value of US$175,000.00.
Country Club 1.00 US Treasury Bills are easily convertible into cash and for the said reason they may be
better classified as cash rather than investments.
—————
The Treasury Bills in question were held as such for many years in view of our
375,865.26 expectation that the Central Bank inspite of the controls would allow no-dollar licenses
importations. However, since the Central Bank did not relax its policy with respect
========= thereto, we decided sometime in 1957 to hold the bills for a few more years in view of
our plan to buy a lot and construct a building of our own. According to the lease
agreement over the building formerly occupied by us in Dasmariñas St., the lease was to
expire sometime in 1957. At that time, the Company was not yet qualified to own real
property in the Philippines. We therefore waited until 60% of the stocks of the Company
would be owned by Filipino citizens before making definite plans. Then in 1959 when
the Company was already more than 60% Filipino owned, we commenced looking for a
suitable location and then finally in 1961, we bought the man lot with an old building on
Otis St., Paco, our present site, for P665,000.00. Adjoining smaller lots were bought later.
After the purchase of the main property, we proceeded with the remodelling of the old
building and the construction of additions, which were completed at a cost of
P143,896.00 in April, 1962.
In view of the needs of the business of this Company and the purchase of the Otis lots and
the construction of the improvements thereon, most of its available funds including the
Treasury Bills had been utilized, but inspite of the said expenses the Company
consistently declared dividends to its stockholders. The Treasury Bills were liquidated
on February 15, 1962.’
Respondent found that the accumulated surplus in question were invested to ‘unrelated
business’ which were not considered in the ‘immediate needs’ of the Company such that
the 25% surtax be imposed therefrom."cralaw virtua1aw library
Petitioner appealed to the Court of Tax Appeals.
On the basis of the tabulated figures, supra, the Court of Tax Appeals found that the
average percentage of cash dividends distributed was 85.77% for a period of 11 years
from 1946 to 1957 and not only 40.33% of the total surplus available for distribution at
the end of each calendar year actually distributed by the petitioner to its stockholders,
which is indicative of the view that the Manila Wine Merchants, Inc. was not formed for
the purpose of preventing the imposition of income tax upon its shareholders. 5
With regards to the alleged substantial investment of surplus or profits in unrelated
business, the Court of Tax Appeals held that the investment of petitioner with Acme
Commercial Co., Inc., Union Insurance Society of Canton and with the Wack Wack Golf
and Country Club are harmless accumulation of surplus and, therefore, not subject to the
25% surtax provided in Section 25 of the Tax Code. 6
As to the U.S.A. Treasury Bonds amounting to P347,217.50, the Court of Tax Appeals
ruled that its purchase was in no way related to petitioner’s business of importing and
selling wines, whisky, liquors and distilled spirits. Respondent Court was convinced that
the surplus of P347,217.50 which was invested in the U.S.A. Treasury Bonds was availed
of by petitioner for the purpose of preventing the imposition of the surtax upon
petitioner’s shareholders by permitting its earnings and profits to accumulate beyond
the reasonable needs of business. Hence, the Court of Tax Appeals modified respondent’s
decision by imposing upon petitioner the 25% surtax for 1957 only in the amount of
P86,804.38 computed as follows:chanrob1es virtual 1aw library
Unreasonable accumulation
of surplus P347,217.50
—————
25% surtax due thereon P 86,804.38 7
On May 30, 1966, the Court of Tax Appeals denied the motion for reconsideration filed by
petitioner on March 30, 1966. Hence, this petition.
Petition assigns the following errors:chanrob1es virtual 1aw library
I
The Court of Tax Appeals erred in holding that petitioner was availed of for the purpose
of preventing the imposition of a surtax on its shareholders.
II
The Court of Tax Appeals erred in holding that petitioner’s purchase of U.S.A. Treasury
Bills in 1951 was an investment in unrelated business subject to the 25% surtax in 1957
as surplus profits improperly accumulated in the latter years.
III
The Court of Tax Appeals erred in not finding that petitioner did not accumulate its
surplus profits improperly in 1957, and in not holding that such surplus profits,
including the so-called unrelated investments, were necessary for its reasonable
business needs.
IV
The Court of Tax Appeals erred in not holding that petitioner had overcome the prima
facie presumption provided for in Section 25(c) of the Revenue Code.
V
 Federal Courts for guidance and enlightenment.chanrobles virtual lawlibrary

The Court of Tax Appeals erred in finding petition liable for the payment of the surtax of A prerequisite to the imposition of the tax has been that the corporation be formed or
P86,804.38 and in denying petitioner’s Motion for Reconsideration and/or New Trial. availed of for the purpose of avoiding the income tax (or surtax) on its shareholders, or
on the shareholders of any other corporation by permitting the earnings and profits of
The issues in this case can be summarized as follows: (1) whether the purchase of the the corporation to accumulate instead of dividing them among or distributing them to
U.S.A. Treasury bonds by petitioner in 1951 can be construed as an investment to an the shareholders. If the earnings and profits were distributed, the shareholders would be
unrelated business and hence, such was availed of by petitioner for the purpose of required to pay an income tax thereon whereas, if the distribution were not made to
preventing the imposition of the surtax upon petitioner’s shareholders by permitting its them, they would incur no tax in respect to the undistributed earnings and profits of the
earnings and profits to accumulate beyond the reasonable needs of the business, and if corporation. 8 The touchstone of liability is the purpose behind the accumulation of the
so, (2) whether the penalty tax of twenty-five percent (25%) can be imposed on such income and not the consequences of the accumulation. 9 Thus, if the failure to pay
improper accumulation in 1957 despite the fact that the accumulation occurred in dividends is due to some other cause, such as the use of undistributed earnings and
1951.chanrobles virtualawlibrary chanrobles.com:chanrobles.com.ph profits for the reasonable needs of the business, such purpose does not fall within the
interdiction of the statute. 10
The pertinent provision of the National Internal Revenue Code reads as
follows:jgc:chanrobles.com.ph An accumulation of earnings or profits (including undistributed earnings or profits of
prior years) is unreasonable if it is not required for the purpose of the business,
"Sec. 25. Additional tax on corporations improperly accumulating profits or surplus. — considering all the circumstances of the case. 11
(a) Imposition of Tax. — If any corporation, except banks, insurance companies, or
personal holding companies whether domestic or foreign, is formed or availed of for the In purchasing the U.S.A. Treasury Bonds, in 1951, petitioner argues that these bonds
purpose of preventing the imposition of the tax upon its shareholders or members or the were so purchased (1) in order to finance their importation; and that a dollar reserve
shareholders or members of another corporation, through the medium of permitting its abroad would be useful to the Company in meeting urgent orders of its local customers
gains and profits to accumulate instead of being divided or distributed, there is levied and (2) to take care of future expansion including the acquisition of a lot and the
and assessed against such corporation, for each taxable year, a tax equal to twenty-five construction of their office building and bottling plant.
per centum of the undistributed portion of its accumulated profits or surplus which shall
be in addition to the tax imposed by section twenty-four and shall be computed, collected We find no merit in the petition.
and paid in the same manner and subject to the same provisions of law, including
penalties, as that tax: Provided, that no such tax shall be levied upon any accumulated To avoid the twenty-five percent (25%) surtax, petitioner has to prove that the purchase
profits or surplus, if they are invested in any dollar-producing or dollar-saving industry of the U.S.A. Treasury Bonds in 1951 with a face value of $175,000.00 was an investment
or in the purchase of bonds issued by the Central Bank of the Philippines. within the reasonable needs of the Corporation.

x x x To determine the "reasonable needs" of the business in order to justify an accumulation

(c) Evidence determinative of purpose. — The fact that the earnings of profits of a
corporation are permitted to accumulate beyond the reasonable needs of the business
shall be determinative of the purpose to avoid the tax upon its shareholders or members
unless the corporation, by clear preponderance of evidence, shall prove the contrary."
(As amended by Republic Act No. 1823).
As correctly pointed out by the Court of Tax Appeals, inasmuch as the provisions of
Section 25 of the National Internal Revenue Code were bodily lifted from Section 102 of
the U.S. Internal Revenue Code of 1939, including the regulations issued in connection
therewith, it would be proper to resort to applicable cases decided by the American
of earnings, the Courts of the United States have invented the so-called "Immediacy Test"
which construed the words "reasonable needs of the business" to mean the immediate
needs of the business, and it was generally held that if the corporation did not prove an
immediate need for the accumulation of the earnings and profits, the accumulation was
not for the reasonable needs of the business, and the penalty tax would apply. 12
American cases likewise hold that investment of the earnings and profits of the
corporation in stock or securities of an unrelated business usually indicates an
accumulation beyond the reasonable needs of the business. 13
The finding of the Court of Tax Appeals that the purchase of the U.S.A. Treasury bonds
were in no way related to petitioner’s business of importing and selling wines whisky,
liquors and distilled spirits, and thus construed as an investment beyond the reasonable
needs of the business 14 is binding on Us, the same being factual. 15 Furthermore, the approve.chanrobles law library
wisdom behind thus finding cannot be doubted, The case of J.M. Perry & Co. v.
Commissioner of Internal Revenue 16 supports the same. In that case, the U.S. Court said In order to determine whether profits are accumulated for the reasonable needs of the
the following:jgc:chanrobles.com.ph business as to avoid the surtax upon shareholders, the controlling intention of the
taxpayer is that which is manifested at the time of accumulation not subsequently
"It appears that the taxpayer corporation was engaged in the business of cold storage declared intentions which are merely the product of afterthought. 19 A speculative and
and wareshousing in Yahima, Washington. It maintained a cold storage plant, divided indefinite purpose will not suffice. The mere recognition of a future problem and the
into four units, having a total capacity of 490,000 boxes of fruits. It presented evidence to discussion of possible and alternative solutions is not sufficient. Definiteness of plan
the effect that various alterations and repairs to its plant were contemplated in the tax coupled with action taken towards its consummation are essential. 20 The Court of Tax
years, . . . Appeals correctly made the following ruling: 21

It also appeared that in spite of the fact that the taxpayer contended that it needed to "As to the statement of Mr. Hawkins in Exh. "B" regarding the expansion program of the
maintain this large cash reserve on hand, it proceeded to make various investments petitioner by purchasing a lot and building of its own, we find no justifiable reason for
which had no relation to its storage business. In 1934, it purchased mining stock which it the retention in 1957 or thereafter of the US Treasury Bonds which were purchased in
sold in 1935 at a profit of US $47,995.29. . . . 1951.

All these things may reasonably have appealed to the Board as incompatible with a x x x
purpose to strengthen the financial position of the taxpayer and to provide for needed
alteration."cralaw virtua1aw library
"Moreover, if there was any thought for the purchase of a lot and building for the needs
The records further reveal that from May 1951 when petitioner purchased the U.S.A. of petitioner’s business, the corporation may not with impunity permit its earnings to
Treasury shares, until 1962 when it finally liquidated the same, it (petitioner) never had pile up merely because at some future time certain outlays would have to be made.
the occasion to use the said shares in aiding or financing its importation. This militates Profits may only be accumulated for the reasonable needs of the business, and implicit in
against the purpose enunciated earlier by petitioner that the shares were purchased to this is further requirement of a reasonable time."cralaw virtua1aw library
finance its importation business. To justify an accumulation of earnings and profits for
the reasonably anticipated future needs, such accumulation must be used within a Viewed on the foregoing analysis and tested under the "immediacy doctrine," We are
reasonable time after the close of the taxable year. 17 convinced that the Court of Tax Appeals is correct in finding that the investment made by
petitioner in the U.S.A. Treasury shares in 1951 was an accumulation of profits in excess
Petitioner advanced the argument that the U.S.A. Treasury shares were held for a few of the reasonable needs of petitioner’s business.
more years from 1957, in view of a plan to buy a lot and construct a building of their
own; that at that time (1957), the Company was not yet qualified to own real property in Finally, petitioner asserts that the surplus profits allegedly accumulated in the form of
the Philippines, hence it (petitioner) had to wait until sixty percent (60%) of the stocks U.S.A. Treasury shares in 1951 by it (petitioner) should not be subject to the surtax in
of the Company would be owned by Filipino citizens before making definite plans. 18 1957. In other words, petitioner claims that the surtax of 25% should be based on the
surplus accumulated in 1951 and not in 1957.
These arguments of petitioner indicate that it considers the U.S.A. Treasury shares not
only for the purpose of aiding or financing its importation but likewise for the purpose of This is devoid of merit.
buying a lot and constructing a building thereon in the near future, but conditioned upon
the completion of the 60% citizenship requirement of stock ownership of the Company The rule is now settled in Our jurisprudence that undistributed earnings or profits of
in order to qualify it to purchase and own a lot. The time when the company would be prior years are taken into consideration in determining unreasonable accumulation for
able to establish itself to meet the said requirement and the decision to pursue the same purposes of the 25% surtax. 22 The case of Basilan Estates, Inc. v. Commissioner of
are dependent upon various future contingencies. Whether these contingencies would Internal Revenue 23 further strengthen this rule, and We quote:jgc:chanrobles.com.ph
unfold favorably to the Company and if so, whether the Company would decide later to
utilize the U.S.A. Treasury shares according to its plan, remains to be seen. From these "Petitioner questions why the examiner covered the period from 1948-1953 when the
assertions of petitioner, We cannot gather anything definite or certain. This, We cannot taxable year on review was 1953. The surplus of P347,507.01 was taken by the examiner
from the balance sheet of the petitioner for 1953. To check the figure arrived at, the
examiner traced the accumulation process from 1947 until 1953, and petitioner’s figure
stood out to be correct. There was no error in the process applied, for previous
accumulations should be considered in determining unreasonable accumulation for the
year concerned.’In determining whether accumulations of earnings or profits in a
particular year are within the reasonable needs of a corporation, it is necessary to take
into account prior accumulations, since accumulations prior to the year involved may
have been sufficient to cover the business needs and additional accumulations during the
year involved would not reasonably be necessary.’" chanroblesvirtuallawlibrary

WHEREFORE, IN VIEW OF THE FOREGOING, the decision of the Court of Tax Appeals is
AFFIRMED in toto, with costs against petitioner.

SO ORDERED.
G.R. No. 85749 May 15, 1989 No investigation was conducted nor a decision rendered on Antonio Tuazon Inc.'s
protest. meantime, the Revenue Commissioner issued warrants of distraint and levy to
COMMISSIONER OF INTERNAL REVENUE, petitioner, enforce collection of the total amount originally assessed including the amounts already
vs. paid.
ANTONIO TUASON, INC. and THE COURT OF TAX APPEALS, respondents.
The private respondent filed a petition for review in the Court of Tax Appeals with a
The Office of the Solicitor General for petitioner. request that pending determination of the case on the merits, an order be issued
restraining the Commissioner and/or his representatives from enforcing the warrants of
Mendoza & Papa and Roman M. Umali for private respondent. distraint and levy. Since the right asserted by the Commissioner to collect the taxes
involved herein by the summary methods of distraint and levy was not clear, and it was
shown that portions of the tax liabilities involved in the assessment had already been
paid, a writ of injunction was issued by the Tax Court on November 26, 1984, ordering
the Commissioner to refrain fron enforcing said warrants of distraint and levy. It did not
GRIÑO-AQUINO, J.:
require the petitioner to file a bond (Annex A, pp. 28-30, Rollo).

Elevated to this Court for review is the decision dated October 14, 1988 of the Court of
In view of the reversal of the Commissioner's decision by the Court of Tax Appeals, the
Tax Appeals in CTA Case No. 3865, entitled "Antonio Tuason, Inc. vs. Commissioner of
petitioner appealed to this Court, raising the following issues:
Internal Revenue," which set aside the petitioner Revenue Commissioner's assessment of
P1,151,146.98 as the 25% surtax on the private respondent's unreasonable
1. Whether or not private respondent Antonio Tuason, Inc. is a
accumulation of surplus for the years 1975-1978.
holding company and/or investment company;

Under date of February 27, 1981, the petitioner, Commissioner of Internal Revenue,
2. Whether or not privaaate respondent Antonio Tuason, Inc.
assessed Antonio Tuason, Inc.
accumulated surplus for the years 1975 to 1978; and

a. Deficiency income tax for the years 1975,1976 and 1978 . . . . . . .

3. Whether or not Antonio Tuason, Inc. is liable for the 25% surtax on
……………………..………… P37,491.83.
undue accumulation of surplus for the years 1975 to 1978.

(b) Deficiency corporate quarterly income tax for the first quarter of
Section 25 of the Tax Code at the time the surtax was assessed, provided:
1975 . . . …. . . . . . . . . . . . . . . . . . 161.49.

Sec. 25. Additional tax on corporation improperly accumulating profits

(c) 25% surtax on unreasonable accumulation of surplus for the years
or surplus.—
1975-1978 . . . . . . . . . . . . 1,151,146.98.

(a) Imposition of tax. — If any corporation, except banks, insurance

The private respondent did not object to the first and second items and, therefore, paid
companies, or personal holding companies, whether domestic or
the amounts demanded. However, it protested the assessment on a 25% surtax on the
foreign, is formed or availed of for the purpose of preventing the
third item on the ground that the accumulation of surplus profits during the years in
imposition of the tax upon its shareholders or members or the
question was solely for the purpose of expanding its business operations as real estate
shareholders or members of another corporation, through the
broker. The request for reinvestigation was granted on condition that a waiver of the
medium of permitting its gains and profits to accumulate instead of
statute of limitations should be filed by the private respondent. The latter replied that
being divided or distributed, there is levied and assessed against such
there was no need of a waiver of the statute of limitaitons because the right of the
corporation, for each taxable year, a tax equal to twenty-five per
Government to assess said tax does not prescribe.
centum of the undistributed portion of its accumulated profits or
surplus which shall be in addition to the tax imposed by section
twenty-four, and shall be computed, collected and paid in the same
 manner and subject to the same provisions of law, including penalties,
as that tax.
(b) Prima facie evidence. — The fact that any corporation is a mere
holding company shall be prima facie evidence of a purpose to avoid
the tax upon its shareholders or members. Similar presumption will
lie in the case of an investment company where at any time during the
taxable year more than fifty per centum in value of its outstanding
stock is owned, directly or indirectly, by one person.
(c) Evidence determinative of purpose. — The fact that the earnings or
profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the
purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the
contrary.
The petition for review is meritorious.
The Court of Tax Appeals conceded that the Revenue Commissioner's determination that
Antonio Tuason, Inc. was a mere holding or investment company, was "presumptively
correct" (p. 7, Annex A), for the corporation did not involve itself in the development of
subdivisions but merely subdivided its own lots and sold them for bigger profits. It
derived its income mostly from interest, dividends and rental realized from the sale of
realty.
Another circumstance supporting that presumption is that 99.99% in value of the
outstanding stock of Antonio Tuason, Inc., is owned by Antonio Tuason himself. The
Commissioner "conclusively presumed" that when the corporation accumulated (instead
of distributing to the shareholders) a surplus of over P3 million fron its earnings in 1975
up to 1978, the purpose was to avoid the imposition of the progressive income tax on its
shareholders.
That Antonio Tuason, Inc. accumulated surplus profits amounting to P3,263,305.88 for
1975 up to 1978 is not disputed. However, the private respondent vehemently denies
that its purpose was to evade payment of the progressive income tax on such dividends
by its stockholders. According to the private respondent, surplus profits were set aside
by the company to build up sufficient capital for its expansion program which included
the construction in 1979-1981 of an apartment building, and the purchase in 1980 of a
condominium unit which was intended for resale or lease.
However, while these investments were actually made, the Commissioner points out that
the corporation did not use up its surplus profits. It allegation that P1,525,672.74 was
spent for the construction of an apartment building in 1979 and P1,752,332.87 for the
purchase of a condominium unit in Urdaneta Village in 1980 was refuted by the
Declaration of Real Property on the apartment building (Exh. C) which shows that its
market value is only P429,890.00, and the Tax Declaration on the condominium unit
which reflects a market value of P293,830.00 only (Exh. D-1). The enormous discrepancy
between the alleged investment cost and the declared market value of these pieces of
real estate was not denied nor explained by the private respondent.
Since the company as of the time of the assessment in 1981, had invested in its business
operations only P 773,720 out of its accumulated surplus profits of P3,263,305.88 for
1975-1978, its remaining accumulated surplus profits of P2,489,858.88 are subject to
the 25% surtax.
All presumptions are in favor of the correctness of petitioner's assessment against the
private respondent. It is incumbent upon the taxpayer to prove the contrary (Mindanao
Bus Company vs. Commissioner of Internal Revenue, 1 SCRA 538). Unfortunately, the
private respondent failed to overcome the presumption of correctness of the
Commissioner's assessment.
The touchstone of liability is the purpose behind the accumulation of the income and not
the consequences of the accumulation. Thus, if the failure to pay dividends were for the
purpose of using the undistributed earnings and profits for the reasonable needs of the
business, that purpose would not fall within the interdiction of the statute" (Mertens Law
of Federal Income Taxation, Vol. 7, Chapter 39, p. 45 cited in Manila Wine Merchants, Inc.
vs. Commissioner of Internal Revenue, 127 SCRA 483, 493).
It is plain to see that the company's failure to distribute dividends to its stockholders in
1975-1978 was for reasons other than the reasonable needs of the business, thereby
falling within the interdiction of Section 25 of the Tax Code of 1977.
WHEREFORE, the appealed decision of the Court of Tax Appeals is hereby set aside. The
petitioner's assessment of a 25% surtax against the Antonio Tuason, Inc. is reinstated
but only on the latter's unspent accumulated surplus profits of P2,489,585.88. No costs.
SO ORDERED.
[G.R. No. 108067. January 20, 2000]
Amount subject to tax

CYANAMID PHILIPPINES, INC., petitioner, vs. THE COURT OF APPEALS, THE COURT Income tax due thereon .25% Surtax 2,385,231.50
OF TAX APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.
Less: Amount already assessed .
DECISION
BALANCE .
QUISUMBING, J.:
_______ monthly interest from ..1,389,636.00

Petitioner disputes the decision[1] of the Court of Appeals which affirmed the _________
decision[2] of the Court of Tax Appeals, ordering petitioner to pay respondent
Commissioner of Internal Revenue the amount of three million, seven hundred seventy- Compromise penalties ...
four thousand, eight hundred sixty seven pesos and fifty centavos (P3,774,867.50) as
25% surtax on improper accumulation of profits for 1981, plus 10% surcharge and 20% TOTAL AMOUNT DUE ..3,774,867.50
annual interest from January 30, 1985 to January 30, 1987, under Sec. 25 of the National
Internal Revenue Code. Sc-lex

The Court of Tax Appeals made the following factual findings:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is
a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged
in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported
finished goods, and an importer/indentor.
On February 7, 1985, the CIR sent an assessment letter to petitioner and demanded the
payment of deficiency income tax of one hundred nineteen thousand eight hundred
seventeen (P119,817.00) pesos for taxable year 1981, as follows:
On March 4, 1985, petitioner protested the assessments particularly, (1) the 25% Surtax
Assessment of P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00;
and 1981 Deficiency Percentage Assessment of P8,846.72.[4] Petitioner, through its
external accountant, Sycip, Gorres, Velayo & Co., claimed, among others, that the surtax
for the undue accumulation of earnings was not proper because the said profits were
retained to increase petitioners working capital and it would be used for reasonable
business needs of the company. Petitioner contended that it availed of the tax amnesty
under Executive Order No. 41, hence enjoyed amnesty from civil and criminal
prosecution granted by the law.

"Net income disclosed by the

On October 20, 1987, the CIR in a letter addressed to SGV & Co., refused to allow the
return as audited 14,575,210.00
cancellation of the assessment notices and rendered its resolution, as follows:
Add: Discrepancies:
"It appears that your client availed of Executive Order No. 41 under
Professional File No. 32A-F-000455-41B as certified and confirmed by our Tax
fees/yr. Amnesty Implementation Office on October 6, 1987.
per 262,877.00
investigation 17018 110,399.37 In reply thereto, I have the honor to inform you that the availment of
the tax amnesty under Executive Order No. 41, as amended is
Total Adjustment 152,477.00 sufficient basis, in appropriate cases, for the cancellation of the
assessment issued after August 21, 1986. (Revenue Memorandum
Net income per Investigation 14,727,687.00 Order No. 4-87) Said availment does not, therefore, result in
cancellation of assessments issued before August 21, 1986, as in the
Less: Personal and additional exemptions ___________
instant case. In other words, the assessments in this case issued on
 January 30, 1985 despite your clients availment of the tax amnesty
under Executive Order No. 41, as amended still subsist.
Such being the case, you are therefore, requested to urge your client
to pay this Office the aforementioned deficiency income tax and surtax
on undue accumulation of surplus in the respective amounts of
P119,817.00 and P3,774,867.50 inclusive of interest thereon for the
year 1981, within thirty (30) days from receipt hereof, otherwise this
office will be constrained to enforce collection thereof thru summary
remedies prescribed by law.
as it claims since it had considerable liquid funds. A thorough review
of petitioners financial statement (particularly the Balance Sheet, p.
127, BIR Records) reveals that the corporation had considerable
liquid funds consisting of cash accounts receivable, inventory and
even its sales for the period is adequate to meet the normal needs of
the business. This can be determined by computing the current asset
to liability ratio of the company:
current
ratio = current assets / current liabilities

This constitutes the final decision of this Office on this matter." [5] = P 47,052,535.00 / P21,275,544.00

Petitioner appealed to the Court of Tax Appeals. During the pendency of the case, = 2.21: 1
however, both parties agreed to compromise the 1981 deficiency income tax assessment
of P119,817.00. Petitioner paid a reduced amount --twenty-six thousand, five hundred
seventy-seven pesos (P26,577.00) -- as compromise settlement. However, the surtax on
improperly accumulated profits remained unresolved.
The significance of this ratio is to serve as a primary test of a
companys solvency to meet current obligations from current assets as
Petitioner claimed that CIRs assessment representing the 25% surtax on its accumulated
a going concern or a measure of adequacy of working capital.
earnings for the year 1981 had no legal basis for the following reasons: (a) petitioner
accumulated its earnings and profits for reasonable business requirements to meet
xxx
working capital needs and retirement of indebtedness; (b) petitioner is a wholly owned
subsidiary of American Cyanamid Company, a corporation organized under the laws of
the State of Maine, in the United States of America, whose shares of stock are listed and We further reject petitioners argument that "the accumulated
traded in New York Stock Exchange. This being the case, no individual shareholder of earnings tax does not apply to a publicly-held corporation" citing
petitioner could have evaded or prevented the imposition of individual income taxes by American jurisprudence to support its position. The reference finds
petitioners accumulation of earnings and profits, instead of distribution of the same. Scl- no application in the case at bar because under Section 25 of the NIRC
aw as amended by Section 5 of P.D. No. 1379 [1739] (dated September
17, 1980), the exceptions to the accumulated earnings tax are
expressly enumerated, to wit: Bank, non-bank financial
In denying the petition, the Court of Tax Appeals made the following pronouncements:
intermediaries, corporations organized primarily, and authorized by
the Central Bank of the Philippines to hold shares of stock of banks,
"Petitioner contends that it did not declare dividends for the year
insurance companies, or personal holding companies, whether
1981 in order to use the accumulated earnings as working capital
domestic or foreign. The law on the matter is clear and specific. Hence,
reserve to meet its "reasonable business needs". The law permits a
there is no need to resort to applicable cases decided by the American
stock corporation to set aside a portion of its retained earnings for
Federal Courts for guidance and enlightenment as to whether the
specified purposes (citing Section 43, paragraph 2 of the Corporation
provision of Section 25 of the NIRC should apply to petitioner. Rtc-
Code of the Philippines). In the case at bar, however, petitioners
spped
purpose for accumulating its earnings does not fall within the ambit of
any of these specified purposes.
Equally clear and specific are the provisions of E.O. 41 particularly
with respect to its effectivity and coverage...
More compelling is the finding that there was no need for petitioner to
set aside a portion of its retained earnings as working capital reserve
 ... Said availment does not result in cancellation of assessments issued
before August 21, 1986 as petitioner seeks to do in the case at bar.
Therefore, the assessments in this case, issued on January 30, 1985
despite petitioners availment of the tax amnesty under E.O. 41 as
amended, still subsist."
xxx
WHEREFORE, petitioner Cyanamid Philippines, Inc., is ordered to pay
respondent Commissioner of Internal Revenue the sum of
P3,774,867.50 representing 25% surtax on improper accumulation of
profits for 1981, plus 10% surcharge and 20% annual interest from
January 30, 1985 to January 30, 1987."[6]
Petitioner appealed the Court of Tax Appeals decision to the Court of Appeals. Affirming
the CTA decision, the appellate court said:
"In reviewing the instant petition and the arguments raised herein,
We find no compelling reason to reverse the findings of the
respondent Court. The respondent Courts decision is supported by
evidence, such as petitioner corporations financial statement and
balance sheets (p. 127, BIR Records). On the other hand the petitioner
corporation could only come up with an alternative formula lifted
from a decision rendered by a foreign court (Bardahl Mfg. Corp. vs.
Commissioner, 24 T.C.M. [CCH] 1030). Applying said formula to its
particular financial position, the petitioner corporation attempts to
justify its accumulated surplus earnings. To Our mind, the petitioner
corporations alternative formula cannot overturn the persuasive
findings and conclusion of the respondent Court based, as it is, on the
applicable laws and jurisprudence, as well as standards in the
computation of taxes and penalties practiced in this jurisdiction.
WHEREFORE, in view of the foregoing, the instant petition is hereby
DISMISSED and the decision of the Court of Tax Appeals dated August
6, 1992 in C.T.A. Case No. 4250 is AFFIRMED in toto."[7]
Hence, petitioner now comes before us and assigns as sole issue:
WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT
THE PETITIONER IS LIABLE FOR THE ACCUMULATED EARNINGS
TAX FOR THE YEAR 1981.[8]
Section 25[9] of the old National Internal Revenue Code of 1977 states: Sd-aad-sc
"Sec. 25. Additional tax on corporation improperly accumulating profits
or surplus -
"(a) Imposition of tax. -- If any corporation is formed or availed of for
the purpose of preventing the imposition of the tax upon its
shareholders or members or the shareholders or members of another
corporation, through the medium of permitting its gains and profits to
accumulate instead of being divided or distributed, there is levied and
assessed against such corporation, for each taxable year, a tax equal to
twenty-five per-centum of the undistributed portion of its
accumulated profits or surplus which shall be in addition to the tax
imposed by section twenty-four, and shall be computed, collected and
paid in the same manner and subject to the same provisions of law,
including penalties, as that tax.
"(b) Prima facie evidence. -- The fact that any corporation is mere
holding company shall be prima facie evidence of a purpose to avoid
the tax upon its shareholders or members. Similar presumption will
lie in the case of an investment company where at any time during the
taxable year more than fifty per centum in value of its outstanding
stock is owned, directly or indirectly, by one person.
"(c) Evidence determinative of purpose. -- The fact that the earnings or
profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the
purpose to avoid the tax upon its shareholders or members unless the
corporation, by clear preponderance of evidence, shall prove the
contrary. M-issdaa
"(d) Exception -- The provisions of this sections shall not apply to
banks, non-bank financial intermediaries, corporation organized
primarily, and authorized by the Central Bank of the Philippines to
hold shares of stock of banks, insurance companies, whether domestic
or foreign.
The provision discouraged tax avoidance through corporate surplus accumulation. When
corporations do not declare dividends, income taxes are not paid on the undeclared
dividends received by the shareholders. The tax on improper accumulation of surplus is
essentially a penalty tax designed to compel corporations to distribute earnings so that
the said earnings by shareholders could, in turn, be taxed.
Relying on decisions of the American Federal Courts, petitioner stresses that the
accumulated earnings tax does not apply to Cyanamid, a wholly owned subsidiary of a
publicly owned company.[10]Specifically, petitioner cites Golconda Mining Corp. vs.
Commissioner, 507 F.2d 594, whereby the U.S. Ninth Circuit Court of Appeals had taken
the position that the accumulated earnings tax could only apply to a closely held
corporation.
A review of American taxation history on accumulated earnings tax will show that the
application of the accumulated earnings tax to publicly held corporations has been
problematic. Initially, the Tax Court and the Court of Claims held that the accumulated
earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of
Appeals ruled in Golconda that the accumulated earnings tax could only apply to closely
held corporations. Despite Golconda, the Internal Revenue Service asserted that the tax
could be imposed on widely held corporations including those not controlled by a few
shareholders or groups of shareholders. The Service indicated it would not follow the
Ninth Circuit regarding publicly held corporations.[11] In 1984, American legislation
nullified the Ninth Circuits Golconda ruling and made it clear that the accumulated
earnings tax is not limited to closely held corporations.[12] Clearly, Golconda is no longer a
reliable precedent. Sl-xm-is
The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739,
enumerated the corporations exempt from the imposition of improperly accumulated
tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d)
corporations organized primarily and authorized by the Central Bank of the Philippines
to hold shares of stocks of banks. Petitioner does not fall among those exempt classes.
Besides, the rule on enumeration is that the express mention of one person, thing, act, or
consequence is construed to exclude all others.[13] Laws granting exemption from tax are
construed strictissimi juris against the taxpayer and liberally in favor of the taxing
power.[14] Taxation is the rule and exemption is the exception. [15] The burden of proof
rests upon the party claiming exemption to prove that it is, in fact, covered by the
exemption so claimed,[16] a burden which petitioner here has failed to discharge.
Another point raised by the petitioner in objecting to the assessment, is that increase of
working capital by a corporation justifies accumulating income. Petitioner asserts that
respondent court erred in concluding that Cyanamid need not infuse additional working
capital reserve because it had considerable liquid funds based on the 2.21:1 ratio of
current assets to current liabilities. Petitioner relies on the so-called "Bardahl" formula,
which allowed retention, as working capital reserve, sufficient amounts of liquid assets
to carry the company through one operating cycle. The "Bardahl"[17] formula was
developed to measure corporate liquidity. The formula requires an examination of
whether the taxpayer has sufficient liquid assets to pay all of its current liabilities and
any extraordinary expenses reasonably anticipated, plus enough to operate the
business during one operating cycle. Operating cycle is the period of time it takes to
convert cash into raw materials, raw materials into inventory, and inventory into sales,
including the time it takes to collect payment for the sales.[18]
Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00 pesos
as working capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner
asserts that Cyanamid had a working capital deficit of P7,986,633.00. [19] Therefore, the
P9,540,926.00 accumulated income as of 1981 may be validly accumulated to increase
the petitioners working capital for the succeeding year.
We note, however, that the companies where the "Bardahl" formula was applied, had
operating cycles much shorter than that of petitioner. In Atlas Tool Co., Inc. vs. CIR,[20] the
companys operating cycle was only 3.33 months or 27.75% of the year. In Cataphote
Corp. of Mississippi vs. United States,[21] the corporations operating cycle was only 56.87
days, or 15.58% of the year. In the case of Cyanamid, the operating cycle was 288.35
days, or 78.55% of a year, reflecting that petitioner will need sufficient liquid funds, of at
least three quarters of the year, to cover the operating costs of the business. There are
variations in the application of the "Bardahl" formula, such as average operating cycle or
peak operating cycle. In times when there is no recurrence of a business cycle, the
working capital needs cannot be predicted with accuracy. As stressed by American
authorities, although the "Bardahl" formula is well-established and routinely applied by
the courts, it is not a precise rule. It is used only for administrative
convenience.[22] Petitioners application of the "Bardahl" formula merely creates a false
illusion of exactitude. Sl-xsc
Other formulas are also used, e.g. the ratio of current assets to current liabilities and the
adoption of the industry standard.[23] The ratio of current assets to current liabilities is
used to determine the sufficiency of working capital. Ideally, the working capital should
equal the current liabilities and there must be 2 units of current assets for every unit of
current liability, hence the so-called "2 to 1" rule.[24]
As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice its
current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in
working capital. Said working capital was expected to increase further when more funds
were generated from the succeeding years sales. Available income covered expenses or
indebtedness for that year, and there appeared no reason to expect an impending
working capital deficit which could have necessitated an increase in working capital, as
rationalized by petitioner.
In Basilan Estates, Inc. vs. Commissioner of Internal Revenue,[25] we held that:
"...[T]here is no need to have such a large amount at the beginning of
the following year because during the year, current assets are
converted into cash and with the income realized from the business as
the year goes, these expenses may well be taken care of. [citation
omitted]. Thus, it is erroneous to say that the taxpayer is entitled to
retain enough liquid net assets in amounts approximately equal to
 current operating needs for the year to cover cost of goods sold and
operating expenses: for it excludes proper consideration of funds
generated by the collection of notes receivable as trade accounts
during the course of the year."[26]
If the CIR determined that the corporation avoided the tax on shareholders by permitting
earnings or profits to accumulate, and the taxpayer contested such a determination, the
burden of proving the determination wrong, together with the corresponding burden of
first going forward with evidence, is on the taxpayer. This applies even if the corporation
is not a mere holding or investment company and does not have an unreasonable
accumulation of earnings or profits.[27]
an expertise on the subject, unless there has been an abuse or improvident exercise of
authority.[31] Unless rebutted, all presumptions generally are indulged in favor of the
correctness of the CIRs assessment against the taxpayer. With petitioners failure to
prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the
correctness of tax courts ruling as affirmed by the Court of Appeals.
WHEREFORE, the instant petition is DENIED, and the decision of the Court of Appeals,
sustaining that of the Court of Tax Appeals, is hereby AFFIRMED. Costs against
petitioner.
SO ORDERED.

In order to determine whether profits are accumulated for the reasonable needs of the
business to avoid the surtax upon shareholders, it must be shown that the controlling
intention of the taxpayer is manifested at the time of accumulation, not intentions
declared subsequently, which are mere afterthoughts.[28] Furthermore, the accumulated
profits must be used within a reasonable time after the close of the taxable year. In the
instant case, petitioner did not establish, by clear and convincing evidence, that such
accumulation of profit was for the immediate needs of the business.

In Manila Wine Merchants, Inc. vs. Commissioner of Internal Revenue,[29] we ruled: xl-aw

"To determine the reasonable needs of the business in order to justify

an accumulation of earnings, the Courts of the United States have
invented the so-called Immediacy Test which construed the words
reasonable needs of the business to mean the immediate needs of the
business, and it was generally held that if the corporation did not
prove an immediate need for the accumulation of the earnings and
profits, the accumulation was not for the reasonable needs of the
business, and the penalty tax would apply. (Mertens, Law of Federal
Income Taxation, Vol. 7, Chapter 39, p. 103).[30]

In the present case, the Tax Court opted to determine the working capital sufficiency by
using the ratio between current assets to current liabilities. The working capital needs of
a business depend upon the nature of the business, its credit policies, the amount of
inventories, the rate of turnover, the amount of accounts receivable, the collection rate,
the availability of credit to the business, and similar factors. Petitioner, by adhering to
the "Bardahl" formula, failed to impress the tax court with the required definiteness
envisioned by the statute. We agree with the tax court that the burden of proof to
establish that the profits accumulated were not beyond the reasonable needs of the
company, remained on the taxpayer. This Court will not set aside lightly the conclusion
reached by the Court of Tax Appeals which, by the very nature of its function, is
dedicated exclusively to the consideration of tax problems and has necessarily developed
 Promulgated:

July 19, 2011

EN BANC

COMMISSIONER OF INTERNAL G. R. No. 163653

REVENUE,
Petitioner,

-versus- x----------------------------------------------------------------------------------------------- x

DECISION

FILINVEST DEVELOPMENT PEREZ, J.:

CORPORATION,
Respondent. Assailed in these twin petitions for review on certiorari filed pursuant to Rule
45 of the 1997 Rules of Civil Procedure are the decisions rendered by the Court of Appeals
(CA) in the following cases: (a) Decision dated 16 December 2003 of the then Special
x-------------------------------------x G. R. No. 167689 Fifth Division in CA-G.R. SP No. 72992;[1] and, (b) Decision dated 26 January 2005 of the
then Fourteenth Division in CA-G.R. SP No. 74510.[2]
COMMISSIONER OF INTERNAL Present:
REVENUE, The Facts
Petitioner, CORONA, C.J.,
CARPIO, The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI),
VELASCO, JR., respondent Filinvest Development Corporation (FDC) is a holding company which also
LEONARDO-DE CASTRO, owned 67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). On 29 November
BRION, 1996, FDC and FAI entered into a Deed of Exchange with FLI whereby the former both
-versus- PERALTA, transferred in favor of the latter parcels of land appraised at P4,306,777,000.00. In
BERSAMIN, exchange for said parcels which were intended to facilitate development of medium-rise
DEL CASTILLO, residential and commercial buildings, 463,094,301 shares of stock of FLI were issued to
ABAD, FDC and FAI.[3] As a result of the exchange, FLIs ownership structure was changed to the
FILINVEST DEVELOPMENT VILLARAMA, JR., extent reflected in the following tabular prcis, viz.:
CORPORATION, PEREZ,
Respondent. MENDOZA, and Stockholder Number and Percentage of Number of Number and Percentage of
SERENO,* JJ. Shares Held Prior to the Additional Shares Held After the
Exchange Shares Issued Exchange

FDC 2,537,358,000 67.42% 42,217,000 2,579,575,000 61.03%

FAI 00 420,877,000 420,877,000 9.96%
OTHERS 1,226,177,000 32.58% 0 1,226,177,000 29.01%
----------------- ----------- -------------- ---------------
3,763,535,000 100% 463,094,301 4,226,629,000 (100%)
On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (BIR) to
the effect that no gain or loss should be recognized in the aforesaid transfer of real
properties. Acting on the request, the BIR issued Ruling No. S-34-046-97 dated 3
February 1997, finding that the exchange is among those contemplated under Section 34
(c) (2) of the old National Internal Revenue Code (NIRC) [4] which provides that (n)o gain
or loss shall be recognized if property is transferred to a corporation by a person in
exchange for a stock in such corporation of which as a result of such exchange said
person, alone or together with others, not exceeding four (4) persons, gains control of
said corporation."[5] With the BIRs reiteration of the foregoing ruling upon the 10
February 1997 request for clarification filed by FLI,[6] the latter, together with FDC and
FAI, complied with all the requirements imposed in the ruling.[7]
On various dates during the years 1996 and 1997, in the meantime, FDC also extended
advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central Corporation
(DSCC) and Filinvest Capital, Inc. (FCI).[8] Duly evidenced by instructional letters as well
as cash and journal vouchers, said cash advances amounted to P2,557,213,942.60 in
1996[9] and P3,360,889,677.48 in 1997.[10] On 15 November 1996, FDC also entered into
a Shareholders Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of a
Singapore-based joint venture company called Filinvest Asia Corporation (FAC), tasked
to develop and manage FDCs 50% ownership of its PBCom Office Tower Project (the
Project). With their equity participation in FAC respectively pegged at 60% and 40% in
the Shareholders Agreement, FDC subscribed to P500.7 million worth of shares in said
joint venture company to RHPLs subscription worth P433.8 million. Having paid its
subscription by executing a Deed of Assignment transferring to FAC a portion of its rights
and interest in the Project worth P500.7 million, FDC eventually reported a net loss
of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996.[11]
On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay
deficiency income and documentary stamp taxes, plus interests and compromise
penalties,[12] covered by the following Assessment Notices, viz.: (a) Assessment Notice
No. SP-INC-96-00018-2000 for deficiency income taxes in the sum of P150,074,066.27
for 1996; (b) Assessment Notice No. SP-DST-96-00020-2000 for deficiency documentary
stamp taxes in the sum of P10,425,487.06 for 1996; (c) Assessment Notice No. SP-INC-
97-00019-2000 for deficiency income taxes in the sum of P5,716,927.03 for 1997; and
(d) Assessment Notice No. SP-DST-97-00021-2000 for deficiency documentary stamp
taxes in the sum of P5,796,699.40 for 1997.[13] The foregoing deficiency taxes were
assessed on the taxable gain supposedly realized by FDC from the Deed of Exchange it
executed with FAI and FLI, on the dilution resulting from the Shareholders Agreement
FDC executed with RHPL as well as the arms-length interest rate and documentary
stamp taxes imposable on the advances FDC extended to its affiliates.[14]
On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand for
deficiency income taxes in the sum of P1,477,494,638.23 for the year 1997.[15]Covered by
Assessment Notice No. SP-INC-97-0027-2000,[16] said deficiency tax was also assessed on
the taxable gain purportedly realized by FAI from the Deed of Exchange it executed with
FDC and FLI.[17] On 26 January 2000 or within the reglementary period of thirty (30)
days from notice of the assessment, both FDC and FAI filed their respective requests for
reconsideration/protest, on the ground that the deficiency income and documentary
stamp taxes assessed by the BIR were bereft of factual and legal basis.[18] Having
submitted the relevant supporting documents pursuant to the 31 January 2000 directive
from the BIR Appellate Division, FDC and FAI filed on 11 September 2000 a letter
requesting an early resolution of their request for reconsideration/protest on the ground
that the 180 days prescribed for the resolution thereof under Section 228 of the NIRC
was going to expire on 20 September 2000.[19]
In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve
their request for reconsideration/protest within the aforesaid period, FDC and FAI filed
on 17 October 2000 a petition for review with the Court of Tax Appeals (CTA) pursuant
to Section 228 of the 1997 NIRC. Docketed before said court as CTA Case No. 6182, the
petition alleged, among other matters, that as previously opined in BIR Ruling No. S-34-
046-97, no taxable gain should have been assessed from the subject Deed of Exchange
since FDC and FAI collectively gained further control of FLI as a consequence of the
exchange; that correlative to the CIR's lack of authority to impute theoretical interests on
the cash advances FDC extended in favor of its affiliates, the rule is settled that interests
cannot be demanded in the absence of a stipulation to the effect; that not being
promissory notes or certificates of obligations, the instructional letters as well as the
cash and journal vouchers evidencing said cash advances were not subject to
documentary stamp taxes; and, that no income tax may be imposed on the prospective
gain from the supposed appreciation of FDC's shareholdings in FAC. As a consequence,
FDC and FAC both prayed that the subject assessments for deficiency income and
documentary stamp taxes for the years 1996 and 1997 be cancelled and annulled.[20]
On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in
question should not be considered tax free since, with the resultant diminution of its
shares in FLI, FDC did not gain further control of said corporation. Likewise calling
attention to the fact that the cash advances FDC extended to its affiliates were interest
free despite the interest bearing loans it obtained from banking institutions, the CIR
invoked Section 43 of the old NIRC which, as implemented by Revenue Regulations No. 2,
Section 179 (b) and (c), gave him "the power to allocate, distribute or apportion income
or deductions between or among such organizations, trades or business in order to
prevent evasion of taxes." The CIR justified the imposition of documentary stamp taxes
on the instructional letters as well as cash and journal vouchers for said cash advances
on the strength of Section 180 of the NIRC and Revenue Regulations No. 9-94 which
provide that loan transactions are subject to said tax irrespective of whether or not they
are evidenced by a formal agreement or by mere office memo. The CIR also argued that
FDC realized taxable gain arising from the dilution of its shares in FAC as a result of its
Shareholders' Agreement with RHPL.[21]
At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and
Issues[22] which was admitted in the 16 February 2001 resolution issued by the CTA.
With the further admission of the Formal Offer of Documentary Evidence subsequently
filed by FDC and FAI[23] and the conclusion of the testimony of Susana Macabelda anent
the cash advances FDC extended in favor of its affiliates,[24] the CTA went on to render
the Decision dated 10 September 2002 which, with the exception of the deficiency
income tax on the interest income FDC supposedly realized from the advances it
extended in favor of its affiliates, cancelled the rest of deficiency income and
documentary stamp taxes assessed against FDC and FAI for the years 1996 and
1997,[25] thus:
WHEREFORE, in view of all the foregoing, the court finds the
instant petition partly meritorious. Accordingly, Assessment Notice
No. SP-INC-96-00018-2000 imposing deficiency income tax on FDC
for taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000
and SP-DST-97-00021-2000 imposing deficiency documentary stamp
tax on FDC for taxable years 1996 and 1997, respectively and
Assessment Notice No. SP-INC-97-0027-2000 imposing deficiency
income tax on FAI for the taxable year 1997 are
hereby CANCELLED and SET ASIDE. However, [FDC] is
hereby ORDERED to PAY the amount of P5,691,972.03 as deficiency
income tax for taxable year 1997. In addition, petitioner is
also ORDERED to PAY 20% delinquency interest computed from
February 16, 2000 until full payment thereof pursuant to Section 249
(c) (3) of the Tax Code.[26]
Finding that the collective increase of the equity participation of FDC and FAI in
FLI rendered the gain derived from the exchange tax-free, the CTA also ruled that the
increase in the value of FDC's shares in FAC did not result in economic advantage in the
absence of actual sale or conversion thereof. While likewise finding that the documents
evidencing the cash advances FDC extended to its affiliates cannot be considered as loan
agreements that are subject to documentary stamp tax, the CTA enunciated, however,
that the CIR was justified in assessing undeclared interests on the same cash advances
pursuant to his authority under Section 43 of the NIRC in order to forestall tax
evasion. For persuasive effect, the CTA referred to the equivalent provision in the
Internal Revenue Code of the United States (IRC-US), i.e., Sec. 482, as implemented by
Section 1.482-2 of 1965-1969 Regulations of the Law of Federal Income Taxation.[27]
Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for
review docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997
Rules of Civil Procedure. Calling attention to the fact that the cash advances it extended to
its affiliates were interest-free in the absence of the express stipulation on interest
required under Article 1956 of the Civil Code, FDC questioned the imposition of an arm's-
length interest rate thereon on the ground, among others, that the CIR's authority under
Section 43 of the NIRC: (a) does not include the power to impute imaginary interest on
said transactions; (b) is directed only against controlled taxpayers and not against
mother or holding corporations; and, (c) can only be invoked in cases of understatement
of taxable net income or evident tax evasion.[28] Upholding FDC's position, the CA's then
Special Fifth Division rendered the herein assailed decision dated 16 December
2003,[29] the decretal portion of which states:
WHEREFORE, premises considered, the instant petition is
hereby GRANTED. The assailed Decision dated September 10, 2002
rendered by the Court of Tax Appeals in CTA Case No. 6182 directing
petitioner Filinvest Development Corporation to pay the amount
of P5,691,972.03 representing deficiency income tax on allegedly
undeclared interest income for the taxable year 1997, plus 20%
delinquency interest computed from February 16, 2000 until full
payment thereof is REVERSED and SET ASIDE and, a new one
entered annulling Assessment Notice No. SP-INC-97-00019-2000
imposing deficiency income tax on petitioner for taxable year
1997. No pronouncement as to costs.[30]
With the denial of its partial motion for reconsideration of the same 11
December 2002 resolution issued by the CTA,[31] the CIR also filed the petition for review
docketed before the CA as CA-G.R. No. 74510. In essence, the CIR argued that the CTA
reversibly erred in cancelling the assessment notices: (a) for deficiency income taxes on
the exchange of property between FDC, FAI and FLI; (b) for deficiency documentary
stamp taxes on the documents evidencing FDC's cash advances to its affiliates; and (c) for
deficiency income tax on the gain FDC purportedly realized from the increase of the
value of its shareholdings in FAC.[32] The foregoing petition was, however, denied due
course and dismissed for lack of merit in the herein assailed decision dated 26 January
2005[33] rendered by the CA's then Fourteenth Division, upon the following findings and
conclusions, to wit:
1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the
29 November 1996 Deed of Exchange resulted in the
combined control by FDC and FAI of more than 51% of the
 outstanding shares of FLI, hence, no taxable gain can be
recognized from the transaction under Section 34 (c) (2) of
the old NIRC;
2. The instructional letters as well as the cash and journal vouchers
evidencing the advances FDC extended to its affiliates are
not subject to documentary stamp taxes pursuant to BIR
Ruling No. 116-98, dated 30 July 1998, since they do not
partake the nature of loan agreements;
3. Although BIR Ruling No. 116-98 had been subsequently modified by
BIR Ruling No. 108-99, dated 15 July 1999, to the effect that
documentary stamp taxes are imposable on inter-office
memos evidencing cash advances similar to those extended
by FDC, said latter ruling cannot be given retroactive
application if to do so would be prejudicial to the taxpayer;
4. FDC's alleged gain from the increase of its shareholdings in FAC as a
consequence of the Shareholders' Agreement it executed
with RHPL cannot be considered taxable income since, until
actually converted thru sale or disposition of said shares,
they merely represent unrealized increase in capital.[34]
Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the
CIR's petitions for review on certiorari assailing the 16 December 2003 decision in CA-
G.R. No. 72992 and the 26 January 2005 decision in CA-G.R. SP No. 74510 were
consolidated pursuant to the 1 March 2006 resolution issued by this Courts Third
Division.
The Issues
In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:
THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF
THE COURT OF TAX APPEALS AND IN HOLDING THAT THE
ADVANCES EXTENDED BY RESPONDENT TO ITS AFFILIATES ARE
NOT SUBJECT TO INCOME TAX.[35]
In G.R. No. 167689, on the other hand, petitioner proffers the following issues for
resolution:
I organizations, trades or businesses. In addition, the CIR asseverates that the CA should
THE HONORABLE COURT OF APPEALS COMMITTED GRAVE
ABUSE OF DISCRETION IN HOLDING THAT THE EXCHANGE OF
SHARES OF STOCK FOR PROPERTY AMONG FILINVEST
DEVELOPMENT CORPORATION (FDC), FILINVEST ALABANG,
INCORPORATED (FAI) AND FILINVEST LAND INCORPORATED
(FLI) MET ALL THE REQUIREMENTS FOR THE NON-RECOGNITION
OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE OLD
NATIONAL INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40
(C) (2) (c) OF THE NIRC.
II
THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE
ERROR IN HOLDING THAT THE LETTERS OF INSTRUCTION OR
CASH VOUCHERS EXTENDED BY FDC TO ITS AFFILIATES ARE NOT
DEEMED LOAN AGREEMENTS SUBJECT TO DOCUMENTARY
STAMP TAXES UNDER SECTION 180 OF THE NIRC.
III
THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN
HOLDING THAT GAIN ON DILUTION AS A RESULT OF THE
INCREASE IN THE VALUE OF FDCS SHAREHOLDINGS IN FAC IS
NOT TAXABLE.[36]
The Courts Ruling
While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in G.R.
No. 167689 impressed with partial merit.
In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding that
theoretical interests can be imputed on the advances FDC extended to its affiliates in
1996 and 1997 considering that, for said purpose, FDC resorted to interest-bearing fund
borrowings from commercial banks. Since considerable interest expenses were deducted
by FDC when said funds were borrowed, the CIR theorizes that interest income should
likewise be declared when the same funds were sourced for the advances FDC extended
to its affiliates. Invoking Section 43 of the 1993 NIRC in relation to Section 179(b) of
Revenue Regulation No. 2, the CIR maintains that it is vested with the power to allocate,
distribute or apportion income or deductions between or among controlled
organizations, trades or businesses even in the absence of fraud, since said power is
intended to prevent evasion of taxes or clearly to reflect the income of any such
have accorded weight and respect to the findings of the CTA which, as the specialized
court dedicated to the study and consideration of tax matters, can take judicial notice of
US income tax laws and regulations.[37]
Admittedly, Section 43 of the 1993 NIRC[38] provides that, (i)n any case of two
or more organizations, trades or businesses (whether or not incorporated and whether
or not organized in the Philippines) owned or controlled directly or indirectly by the
same interests, the Commissioner of Internal Revenue is authorized to distribute,
apportion or allocate gross income or deductions between or among such organization,
trade or business, if he determines that such distribution, apportionment or allocation is
necessary in order to prevent evasion of taxes or clearly to reflect the income of any such
organization, trade or business. In amplification of the equivalent provision [39] under
Commonwealth Act No. 466,[40] Sec. 179(b) of Revenue Regulation No. 2 states as
follows:
Determination of the taxable net income of controlled
taxpayer. (A) DEFINITIONS. When used in this section
(1) The term organization includes any kind, whether
it be a sole proprietorship, a partnership, a trust, an estate, or a
corporation or association, irrespective of the place where organized,
where operated, or where its trade or business is conducted, and
regardless of whether domestic or foreign, whether exempt or
taxable, or whether affiliated or not.
(2) The terms trade or business include any trade or
business activity of any kind, regardless of whether or where
organized, whether owned individually or otherwise, and regardless
of the place where carried on.
(3) The term controlled includes any kind of control,
direct or indirect, whether legally enforceable, and however
exercisable or exercised. It is the reality of the control which is
decisive, not its form or mode of exercise. A presumption of control
arises if income or deductions have been arbitrarily shifted.
(4) The term controlled taxpayer means any one of
two or more organizations, trades, or businesses owned or controlled
directly or indirectly by the same interests.
(5) The term group and group of controlled taxpayers
means the organizations, trades or businesses owned or controlled by
the same interests.
(6) The term true net income means, in the case of a
controlled taxpayer, the net income (or as the case may be, any item
or element affecting net income) which would have resulted to the
controlled taxpayer, had it in the conduct of its affairs (or, as the case
may be, any item or element affecting net income) which would have
resulted to the controlled taxpayer, had it in the conduct of its affairs
(or, as the case may be, in the particular contract, transaction,
arrangement or other act) dealt with the other members or members
of the group at arms length. It does not mean the income, the
deductions, or the item or element of either, resulting to the
controlled taxpayer by reason of the particular contract, transaction,
or arrangement, the controlled taxpayer, or the interest controlling it,
chose to make (even though such contract, transaction, or
arrangement be legally binding upon the parties thereto).
(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the
Tax Code is to place a controlled taxpayer on a tax parity with an
uncontrolled taxpayer, by determining, according to the standard of
an uncontrolled taxpayer, the true net income from the property and
business of a controlled taxpayer. The interests controlling a group of
controlled taxpayer are assumed to have complete power to cause
each controlled taxpayer so to conduct its affairs that its transactions
and accounting records truly reflect the net income from the property
and business of each of the controlled taxpayers. If, however, this has
not been done and the taxable net income are thereby understated,
the statute contemplates that the Commissioner of Internal Revenue
shall intervene, and, by making such distributions, apportionments, or
allocations as he may deem necessary of gross income or deductions,
or of any item or element affecting net income, between or among the
controlled taxpayers constituting the group, shall determine the true
net income of each controlled taxpayer. The standard to be applied in
every case is that of an uncontrolled taxpayer. Section 44 grants no
right to a controlled taxpayer to apply its provisions at will, nor does
it grant any right to compel the Commissioner of Internal Revenue to
apply its provisions.
(C) APPLICATION Transactions between controlled taxpayer
and another will be subjected to special scrutiny to ascertain whether
the common control is being used to reduce, avoid or escape taxes. In
determining the true net income of a controlled taxpayer, the
Commissioner of Internal Revenue is not restricted to the case of
improper accounting, to the case of a fraudulent, colorable, or sham
transaction, or to the case of a device designed to reduce or avoid tax
by shifting or distorting income or deductions. The authority to
determine true net income extends to any case in which either by
inadvertence or design the taxable net income in whole or in part, of a
controlled taxpayer, is other than it would have been had the taxpayer
in the conduct of his affairs been an uncontrolled taxpayer dealing at
arms length with another uncontrolled taxpayer.[41]
 As may be gleaned from the definitions of the terms controlled and "controlled
taxpayer" under paragraphs (a) (3) and (4) of the foregoing provision, it would appear
that FDC and its affiliates come within the purview of Section 43 of the 1993 NIRC. Aside
from owning significant portions of the shares of stock of FLI, FAI, DSCC and FCI, the fact
that FDC extended substantial sums of money as cash advances to its said affiliates for
the purpose of providing them financial assistance for their operational and capital
expenditures seemingly indicate that the situation sought to be addressed by the subject
provision exists. From the tenor of paragraph (c) of Section 179 of Revenue Regulation
No. 2, it may also be seen that the CIR's power to distribute, apportion or allocate gross
income or deductions between or among controlled taxpayers may be likewise exercised
whether or not fraud inheres in the transaction/s under scrutiny. For as long as the
controlled taxpayer's taxable income is not reflective of that which it would have realized
had it been dealing at arm's length with an uncontrolled taxpayer, the CIR can make the
necessary rectifications in order to prevent evasion of taxes.
Despite the broad parameters provided, however, we find that the CIR's powers
of distribution, apportionment or allocation of gross income and deductions under
Section 43 of the 1993 NIRC and Section 179 of Revenue Regulation No. 2 does not
include the power to impute "theoretical interests" to the controlled taxpayer's
transactions. Pursuant to Section 28 of the 1993 NIRC,[42] after all, the term gross income
is understood to mean all income from whatever source derived, including, but not
limited to the following items: compensation for services, including fees, commissions,
and similar items; gross income derived from business; gains derived from dealings in
property; interest; rents; royalties; dividends; annuities; prizes and winnings; pensions;
and partners distributive share of the gross income of general professional
partnership.[43] While it has been held that the phrase "from whatever source derived"
indicates a legislative policy to include all income not expressly exempted within the
class of taxable income under our laws, the term "income" has been variously
interpreted to mean "cash received or its equivalent", "the amount of money coming to a
person within a specific time" or "something distinct from principal or
capital."[44] Otherwise stated, there must be proof of the actual or, at the very least,
probable receipt or realization by the controlled taxpayer of the item of gross income
sought to be distributed, apportioned or allocated by the CIR.
Our circumspect perusal of the record yielded no evidence of actual or possible
showing that the advances FDC extended to its affiliates had resulted to the interests
subsequently assessed by the CIR. For all its harping upon the supposed fact that FDC
had resorted to borrowings from commercial banks, the CIR had adduced no concrete
proof that said funds were, indeed, the source of the advances the former provided its
affiliates. While admitting that FDC obtained interest-bearing loans from commercial
banks,[45] Susan Macabelda - FDC's Funds Management Department Manager who was
the sole witness presented before the CTA - clarified that the subject advances were
sourced from the corporation's rights offering in 1995 as well as the sale of its
investment in Bonifacio Land in 1997.[46] More significantly, said witness testified that
said advances: (a) were extended to give FLI, FAI, DSCC and FCI financial assistance for
their operational and capital expenditures; and, (b) were all temporarily in nature since
they were repaid within the duration of one week to three months and were evidenced
by mere journal entries, cash vouchers and instructional letters.[47]
Even if we were, therefore, to accord precipitate credulity to the CIR's bare
assertion that FDC had deducted substantial interest expense from its gross income,
there would still be no factual basis for the imputation of theoretical interests on the
subject advances and assess deficiency income taxes thereon. More so, when it is borne
in mind that, pursuant to Article 1956 of the Civil Code of the Philippines, no interest shall
be due unless it has been expressly stipulated in writing. Considering that taxes, being
burdens, are not to be presumed beyond what the applicable statute expressly and
clearly declares,[48] the rule is likewise settled that tax statutes must be construed strictly
against the government and liberally in favor of the taxpayer.[49] Accordingly, the general
rule of requiring adherence to the letter in construing statutes applies with peculiar
strictness to tax laws and the provisions of a taxing act are not to be extended by
implication.[50] While it is true that taxes are the lifeblood of the government, it has been
held that their assessment and collection should be in accordance with law as any
arbitrariness will negate the very reason for government itself.[51]
In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the
imposition of deficiency income taxes on the transfer FDC and FAI effected in exchange
for the shares of stock of FLI. With respect to the Deed of Exchange executed between
FDC, FAI and FLI, Section 34 (c) (2) of the 1993 NIRC pertinently provides as follows:
Sec. 34. Determination of amount of and recognition of
gain or loss.-
xxxx
(c) Exception x x x x
No gain or loss shall also be recognized if property is transferred to a
corporation by a person in exchange for shares of stock in such
corporation of which as a result of such exchange said person, alone or
together with others, not exceeding four persons, gains control of said
corporation; Provided, That stocks issued for services shall not be
considered as issued in return of property.
As even admitted in the 14 February 2001 Stipulation of Facts submitted by the
parties,[52] the requisites for the non-recognition of gain or loss under the foregoing
provision are as follows: (a) the transferee is a corporation; (b) the transferee exchanges
its shares of stock for property/ies of the transferor; (c) the transfer is made by a person,
acting alone or together with others, not exceeding four persons; and, (d) as a result of
the exchange the transferor, alone or together with others, not exceeding four, gains
control of the transferee.[53] Acting on the 13 January 1997 request filed by FLI, the BIR
had, in fact, acknowledged the concurrence of the foregoing requisites in the Deed of
Exchange the former executed with FDC and FAI by issuing BIR Ruling No. S-34-046-
97.[54] With the BIR's reiteration of said ruling upon the request for clarification filed by
FLI,[55] there is also no dispute that said transferee and transferors subsequently
complied with the requirements provided for the non-recognition of gain or loss from
the exchange of property for tax, as provided under Section 34 (c) (2) of the 1993
NIRC.[56]
Then as now, the CIR argues that taxable gain should be recognized for the exchange
considering that FDC's controlling interest in FLI was actually decreased as a result
thereof. For said purpose, the CIR calls attention to the fact that, prior to the exchange,
FDC owned 2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding capital
stock.Upon the issuance of 443,094,000 additional FLI shares as a consequence of the
exchange and with only 42,217,000 thereof accruing in favor of FDC for a total of
2,579,575,000 shares, said corporations controlling interest was supposedly reduced to
61%.03 when reckoned from the transferee's aggregate 4,226,629,000 outstanding
shares. Without owning a share from FLI's initial 3,763,535,000 outstanding shares, on
the other hand, FAI's acquisition of 420,877,000 FLI shares as a result of the exchange
purportedly resulted in its control of only 9.96% of said transferee corporation's
4,226,629,000 outstanding shares. On the principle that the transaction did not qualify as
a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC, the CIR asseverates that
taxable gain in the sum of P263,386,921.00 should be recognized on the part of FDC and
in the sum of P3,088,711,367.00 on the part of FAI.[57]
The paucity of merit in the CIR's position is, however, evident from the categorical
language of Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will not
be recognized in case the exchange of property for stocks results in the control of the
transferee by the transferor, alone or with other transferors not exceeding four
persons.Rather than isolating the same as proposed by the CIR, FDC's 2,579,575,000
shares or 61.03% control of FLI's 4,226,629,000 outstanding shares should, therefore, be
appreciated in combination with the 420,877,000 new shares issued to FAI which
represents 9.96% control of said transferee corporation. Together FDC's 2,579,575,000
shares (61.03%) and FAI's 420,877,000 shares (9.96%) clearly add up to 3,000,452,000
shares or 70.99% of FLI's 4,226,629,000 shares. Since the term "control" is clearly
defined as "ownership of stocks in a corporation possessing at least fifty-one percent of
the total voting power of classes of stocks entitled to one vote" under Section 34 (c) (6)
[c] of the 1993 NIRC, the exchange of property for stocks between FDC FAI and FLI
clearly qualify as a tax-free transaction under paragraph 34 (c) (2) of the same provision.
Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme
Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law
and Jurisprudence, opined that said provision could be inapplicable if control is already
vested in the exchangor prior to exchange.[58] Aside from the fact that that the 10
September 2002 Decision in CTA Case No. 6182 upholding the tax-exempt status of the
exchange between FDC, FAI and FLI was penned by no less than Justice Acosta
himself,[59] FDC and FAI significantly point out that said authors have acknowledged that
the position taken by the BIR is to the effect that "the law would apply even when the
exchangor already has control of the corporation at the time of the exchange." [60] This
was confirmed when, apprised in FLI's request for clarification about the change of
percentage of ownership of its outstanding capital stock, the BIR opined as follows:
Please be informed that regardless of the foregoing, the
transferors, Filinvest Development Corp. and Filinvest Alabang, Inc.
still gained control of Filinvest Land, Inc. The term 'control' shall mean
ownership of stocks in a corporation by possessing at least 51% of the
total voting power of all classes of stocks entitled to vote. Control is
determined by the amount of stocks received, i.e., total subscribed,
whether for property or for services by the transferor or
transferors. In determining the 51% stock ownership, only those
persons who transferred property for stocks in the same transaction
may be counted up to the maximum of five (BIR Ruling No. 547-93
dated December 29, 1993.[61]
At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by
the CIR is more apparent than real. As the uncontested owner of 80% of the outstanding
shares of FAI, it cannot be gainsaid that FDC ideally controls the same percentage of the
420,877,000 shares issued to its said co-transferor which, by itself, represents 7.968% of
the outstanding shares of FLI. Considered alongside FDC's 61.03% control of FLI as a
consequence of the 29 November 1996 Deed of Transfer, said 7.968% add up to an
aggregate of 68.998% of said transferee corporation's outstanding shares of stock which
is evidently still greater than the 67.42% FDC initially held prior to the exchange. This
much was admitted by the parties in the 14 February 2001 Stipulation of Facts,
Documents and Issues they submitted to the CTA.[62] Inasmuch as the combined
ownership of FDC and FAI of FLI's outstanding capital stock adds up to a total of 70.99%,
it stands to reason that neither of said transferors can be held liable for deficiency
income taxes the CIR assessed on the supposed gain which resulted from the subject
transfer.
On the other hand, insofar as documentary stamp taxes on loan agreements and
promissory notes are concerned, Section 180 of the NIRC provides follows:
Sec. 180. Stamp tax on all loan agreements, promissory notes,
bills of exchange, drafts, instruments and securities issued by the
government or any of its instrumentalities, certificates of deposit
bearing interest and others not payable on sight or demand. On
all loan agreements signed abroad wherein the object of the contract is
 located or used in the Philippines; bill of exchange (between points
within the Philippines), drafts, instruments and securities issued by the
Government or any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of money
otherwise than at sight or on demand, or on all promissory notes,
whether negotiable or non-negotiable, except bank notes issued for
circulation, and on each renewal of any such note, there shall be
collected a documentary stamp tax of Thirty centavos (P0.30) on each
two hundred pesos, or fractional part thereof, of the face value of any
such agreement, bill of exchange, draft, certificate of deposit or
note: Provided, That only one documentary stamp tax shall be imposed
on either loan agreement, or promissory notes issued to secure such
loan, whichever will yield a higher tax: Provided however, That loan
agreements or promissory notes the aggregate of which does not exceed
Two hundred fifty thousand pesos (P250,000.00) executed by an
individual for his purchase on installment for his personal use or that of
his family and not for business, resale, barter or hire of a house, lot,
motor vehicle, appliance or furniture shall be exempt from the payment
of documentary stamp tax provided under this Section.
When read in conjunction with Section 173 of the 1993 NIRC,[63] the foregoing provision
concededly applies to "(a)ll loan agreements, whether made or signed in the Philippines,
or abroad when the obligation or right arises from Philippine sources or the property or
object of the contract is located or used in the Philippines." Correlatively, Section 3 (b)
and Section 6 of Revenue Regulations No. 9-94 provide as follows:
Section 3. Definition of Terms. For purposes of these Regulations, the
following term shall mean:
(b) 'Loan agreement' refers to a contract in writing where one of the
parties delivers to another money or other consumable thing, upon
the condition that the same amount of the same kind and quality shall
be paid. The term shall include credit facilities, which may be
evidenced by credit memo, advice or drawings.
The terms 'Loan Agreement" under Section 180 and "Mortgage' under
Section 195, both of the Tax Code, as amended, generally refer to
distinct and separate instruments. A loan agreement shall be taxed
under Section 180, while a deed of mortgage shall be taxed under
Section 195."
"Section 6. Stamp on all Loan Agreements. All loan agreements
whether made or signed in the Philippines, or abroad when the
obligation or right arises from Philippine sources or the property or
object of the contract is located in the Philippines shall be subject to
the documentary stamp tax of thirty centavos (P0.30) on each two
hundred pesos, or fractional part thereof, of the face value of any such
agreements, pursuant to Section 180 in relation to Section 173 of the
Tax Code.
In cases where no formal agreements or promissory notes
have been executed to cover credit facilities, the documentary stamp
tax shall be based on the amount of drawings or availment of the
facilities, which may be evidenced by credit/debit memo, advice or
drawings by any form of check or withdrawal slip, under Section 180
of the Tax Code.
Applying the aforesaid provisions to the case at bench, we find that the
instructional letters as well as the journal and cash vouchers evidencing the advances
FDC extended to its affiliates in 1996 and 1997 qualified as loan agreements upon which
documentary stamp taxes may be imposed. In keeping with the caveat attendant to every
BIR Ruling to the effect that it is valid only if the facts claimed by the taxpayer are
correct, we find that the CA reversibly erred in utilizing BIR Ruling No. 116-98, dated 30
July 1998 which, strictly speaking, could be invoked only by ASB Development
Corporation, the taxpayer who sought the same. In said ruling, the CIR opined that
documents like those evidencing the advances FDC extended to its affiliates are not
subject to documentary stamp tax, to wit:
On the matter of whether or not the inter-office memo covering the
advances granted by an affiliate company is subject to documentary
stamp tax, it is informed that nothing in Regulations No. 26
(Documentary Stamp Tax Regulations) and Revenue Regulations No.
9-94 states that the same is subject to documentary stamp tax. Such
being the case, said inter-office memo evidencing the lendings or
borrowings which is neither a form of promissory note nor a
certificate of indebtedness issued by the corporation-affiliate or a
certificate of obligation, which are, more or less, categorized as
'securities', is not subject to documentary stamp tax imposed under
Section 180, 174 and 175 of the Tax Code of 1997,
respectively. Rather, the inter-office memo is being prepared for
accounting purposes only in order to avoid the co-mingling of funds of
the corporate affiliates.
In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in
BIR Ruling No. 108-99 dated 15 July 1999, which opined that inter-office memos
evidencing lendings or borrowings extended by a corporation to its affiliates are akin to
promissory notes, hence, subject to documentary stamp taxes.[64] In brushing aside the
foregoing argument, however, the CA applied Section 246 of the 1993 NIRC[65] from
which proceeds the settled principle that rulings, circulars, rules and regulations
promulgated by the BIR have no retroactive application if to so apply them would be
prejudicial to the taxpayers.[66] Admittedly, this rule does not apply: (a) where the
taxpayer deliberately misstates or omits material facts from his return or in any
document required of him by the Bureau of Internal Revenue; (b) where the facts
subsequently gathered by the Bureau of Internal Revenue are materially different from
the facts on which the ruling is based; or (c) where the taxpayer acted in bad faith.[67] Not
being the taxpayer who, in the first instance, sought a ruling from the CIR, however, FDC
cannot invoke the foregoing principle on non-retroactivity of BIR rulings.
Viewed in the light of the foregoing considerations, we find that both the CTA and the CA
erred in invalidating the assessments issued by the CIR for the deficiency documentary
stamp taxes due on the instructional letters as well as the journal and cash vouchers
evidencing the advances FDC extended to its affiliates in 1996 and 1997. In Assessment
Notice No. SP-DST-96-00020-2000, the CIR correctly assessed the sum of P6,400,693.62
for documentary stamp tax, P3,999,793.44 in interests and P25,000.00 as compromise
penalty, for a total of P10,425,487.06. Alongside the sum of P4,050,599.62 for
documentary stamp tax, the CIR similarly assessed P1,721,099.78 in interests
and P25,000.00 as compromise penalty in Assessment Notice No. SP-DST-97-00021-
2000 or a total of P5,796,699.40. The imposition of deficiency interest is justified under
Sec. 249 (a) and (b) of the NIRC which authorizes the assessment of the same at the rate
of twenty percent (20%), or such higher rate as may be prescribed by regulations, from
the date prescribed for the payment of the unpaid amount of tax until full
payment.[68] The imposition of the compromise penalty is, in turn, warranted under Sec.
250[69] of the NIRC which prescribes the imposition thereof in case of each failure to file
an information or return, statement or list, or keep any record or supply any information
required on the date prescribed therefor.
To our mind, no reversible error can, finally, be imputed against both the CTA and the CA
for invalidating the Assessment Notice issued by the CIR for the deficiency income taxes
FDC is supposed to have incurred as a consequence of the dilution of its shares in
FAC. Anent FDCs Shareholders Agreement with RHPL, the record shows that the parties
were in agreement about the following factual antecedents narrated in the 14 February
2001 Stipulation of Facts, Documents and Issues they submitted before the CTA,[70] viz.:
1.11. On November 15, 1996, FDC entered into a Shareholders
Agreement (SA) with Reco Herrera Pte. Ltd. (RHPL) for the formation
of a joint venture company named Filinvest Asia Corporation (FAC)
which is based in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and
7, Answer).
1.12. FAC, the joint venture company formed by FDC and RHPL, is
tasked to develop and manage the 50% ownership interest of FDC in
its PBCom Office Tower Project (Project) with the Philippine Bank of
Communications (par. 6.12, Petition; par. 7, Answer).
1.13. Pursuant to the SA between FDC and RHPL, the equity
participation of FDC and RHPL in FAC was 60% and 40% respectively.
1.14. In accordance with the terms of the SA, FDC subscribed
to P500.7 million worth of shares of stock representing a 60% equity
participation in FAC. In turn, RHPL subscribed to P433.8 million
worth of shares of stock of FAC representing a 40% equity
participation in FAC.
1.15. In payment of its subscription in FAC, FDC executed a
Deed of Assignment transferring to FAC a portion of FDCs right and
interests in the Project to the extent of P500.7 million.
1.16. FDC reported a net loss of P190,695,061.00 in its
Annual Income Tax Return for the taxable year 1996.[71]
Alongside the principle that tax revenues are not intended to be liberally
construed,[72] the rule is settled that the findings and conclusions of the CTA are accorded
great respect and are generally upheld by this Court, unless there is a clear showing of a
reversible error or an improvident exercise of authority.[73] Absent showing of such error
here, we find no strong and cogent reasons to depart from said rule with respect to the
CTA's finding that no deficiency income tax can be assessed on the gain on the supposed
dilution and/or increase in the value of FDC's shareholdings in FAC which the CIR, at any
rate, failed to establish. Bearing in mind the meaning of "gross income" as above
discussed, it cannot be gainsaid, even then, that a mere increase or appreciation in the
value of said shares cannot be considered income for taxation purposes. Since a mere
advance in the value of the property of a person or corporation in no sense constitute the
income specified in the revenue law, it has been held in the early case of Fisher vs.
Trinidad,[74] that it constitutes and can be treated merely as an increase of capital. Hence,
the CIR has no factual and legal basis in assessing income tax on the increase in the value
of FDC's shareholdings in FAC until the same is actually sold at a profit.
WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No.
163653 is DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R. No.
72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 is PARTIALLY
GRANTED and the CAs 26 January 2005 Decision in CA-G.R. SP No. 74510 is MODIFIED.
Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-
00021-2000 issued for deficiency documentary stamp taxes due on the instructional
letters as well as journal and cash vouchers evidencing the advances FDC extended to its
affiliates are declared valid.

The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-

97-00019-2000 and SP-INC-97-0027-2000 issued for deficiency income assessed on (a)
the arms-length interest from said advances; (b) the gain from FDCs Deed of Exchange
with FAI and FLI; and (c) income from the dilution resulting from FDCs Shareholders
Agreement with RHPL is, however, upheld.
SO ORDERED.
 Indexed as: Canada v. GlaxoSmithKline Inc.
SUPREME COURT OF CANADA

CITATION: Canada v. GlaxoSmithKline Inc., 2012 SCC 52, [2012] 3 S.C.R. 3 DATE: 20121018
2012 SCC 52 DOCKET: 33874

BETWEEN:
Her Majesty The Queen
File No.: 33874.
Appellant/Respondent on cross-appeal
and
GlaxoSmithKline Inc.
Respondent/Appellant on cross-appeal
2012: January 13; 2012: October 18.

CORAM: McLachlin C.J. and Deschamps, Abella, Rothstein, Cromwell, Moldaver and
Karakatsanis JJ.
Present: McLachlin C.J. and Deschamps, Abella, Rothstein, Cromwell, Moldaver and
Karakatsanis JJ.
REASONS FOR JUDGMENT: Rothstein J. (McLachlin C.J. and Deschamps, Abella,
(paras. 1 to 77) Cromwell, Moldaver and Karakatsanis JJ. concurring)

ON APPEAL FROM THE FEDERAL COURT OF APPEAL

Taxation ― Income Tax ― Transfer Pricing ― Taxpayer manufacturing and

marketing patented and trademarked drug pursuant to Licence Agreement ― Taxpayer
purchasing active pharmaceutical ingredient pursuant to separate Supply Agreement with
related non-resident company ― Minister of National Revenue reassessing taxpayer by
increasing its income on basis that taxpayer had overpaid non-arm’s length supplier for
Canada v. GlaxoSmithKline Inc., 2012 SCC 52, [2012] 3 S.C.R. 3 purchase of drug ingredient ― Minister not considering effect of Licence Agreement on
reasonableness of price paid for ingredient under Supply Agreement ― What circumstances
are to be taken into account in determining reasonable arm’s length price against which to
compare non-arm’s length transfer price? ― Whether Licence Agreement is a circumstance
Her Majesty The Queen Appellant/Respondent on cross-appeal to be taken into account ― Whether Federal Court of Appeal erred in remitting matter to
Tax Court for rehearing and reconsideration ― Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp .), s. 69(2) .

v.
Between 1990 and 1993, the respondent, GlaxoSmithKline Inc. (“Glaxo
Canada”), purchased ranitidine, the active pharmaceutical ingredient in the brand name
anti-ulcer drug Zantac, from Adechsa S.A., a related non-resident company, for between
GlaxoSmithKline Inc. Respondent/Appellant on cross-appeal $1,512 and $1,651 per kilogram. During the same period, two Canadian generic
pharmaceutical companies, Apotex Inc. and Novopharm Ltd., purchased ranitidine from
other sources for use in their generic anti-ulcer drugs for between $194 and $304 per
kilogram from arm’s length suppliers.
A Licence Agreement conferred rights and benefits on Glaxo Canada and a
Supply Agreement set the transfer prices of ranitidine. The combined effect of the
Licence and Supply agreements enabled Glaxo Canada, among other things, to purchase
ranitidine, put it in a delivery mechanism, and market it under the trademark Zantac.
The appellant, the Minister of National Revenue, reassessed Glaxo Canada for
the taxation years 1990, 1991, 1992, and 1993, pursuant to the then applicable s. 69(2)
of the Act (now s. 247(2)) on the basis that the prices it paid for ranitidine were greater
than an amount that would have been reasonable in the circumstances had they been
dealing at arm’s length. Glaxo Canada appealed to the Tax Court of Canada, where, with
one minor revision, the reassessment was upheld on the basis that the Licence and
Supply agreements were to be considered independently. The Federal Court of Appeal
allowed the appeal and remitted the matter back to the Tax Court for redetermination of
the “reasonable amount” payable for Glaxo Canada’s ranitidine transactions.
Held: The appeal and cross-appeal should be dismissed.
Section 69(2) requires the court to determine whether the transfer price was
greater than the amount that would have been reasonable in the circumstances, had the
parties been dealing at arm’s length. If transactions other than the purchasing
transaction are relevant in determining this question, they must not be
ignored. Section 69(2) does not, itself, offer guidance as to how to determine the
“reasonable amount” that would have been payable had the parties been dealing at arm’s
length. The OECD’s 1979 Guidelines and the OECD’s 1995 Guidelines are not controlling
as if they were a Canadian statute. However, they suggest a number of methods for
determining whether transfer prices are consistent with prices determined between
parties dealing at arm’s length.
A proper application of the arm’s length principle requires that regard be had
for the “economically relevant characteristics” of the arm’s length and non-arm’s length
circumstances to ensure they are “sufficiently comparable”. Where there are no related
transactions or where related transactions are not relevant to the determination of the
reasonableness of the price in issue, a transaction-by-transaction approach may be
appropriate. However, “economically relevant characteristics of the situations being
compared” may make it necessary to consider other transactions that impact the transfer
price under consideration. In each case, it is necessary to address this question by
considering the relevant circumstances and, if required, transactions other than the
purchasing transactions must be taken into account.
Such circumstances will include agreements that may confer rights and
benefits in addition to the purchase of property where those agreements are linked to
the purchasing agreement. The objective is to determine what an arm’s length purchaser
would pay for the property and the rights and benefits together where the rights and
benefits are linked to the price paid for the property. However, transfer pricing is not an
exact science and it is highly unlikely that any comparisons will yield identical
circumstances and the court will be required to exercise its best informed judgment in
establishing a satisfactory arm’s length price.
In this case, Glaxo Canada was paying for at least some of the rights and
benefits under the Licence Agreement as part of the purchase prices for ranitidine from
Adechsa. As such, the Licence Agreement could not be ignored in determining the
reasonable amount paid to Adechsa under s. 69(2), which applies not only to payment
for goods but also to payment for services. Considering the Licence and Supply
Agreements together offers a realistic picture of the profits of Glaxo Canada. The prices
paid by Glaxo Canada to Adechsa were a payment for a bundle of at least some rights and
benefits under the Licence Agreement and product under the Supply Agreement. The
generic comparators used by the Tax Court do not reflect the economic and business
reality of Glaxo Canada and, at least without adjustment, do not indicate the price that
would be reasonable in the circumstances, had Glaxo Canada and Adechsa been dealing
at arm’s length. It is only after identifying the circumstances arising from the Licence
Agreement that are linked to the Supply Agreement that arm’s length comparisons under
any of the OECD methods or other methods may be determined.
The assumption that the prices paid by Glaxo Canada for ranitidine were
greater than the amount that would have been reasonable in the circumstances had
Glaxo Canada and Adechsa been dealing at arm’s length has not been demolished. As
found by the Federal Court of Appeal, the matter should be remitted to the Tax Court to
be redetermined, having regard to the effect of the Licence Agreement on the prices paid
by Glaxo Canada for the supply of ranitidine from Adechsa. Whether or not
compensation for intellectual property rights is justified in this particular case is a
matter for determination by the Tax Court.
Cases Cited
 Distinguished: Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046; Shell
Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; referred to: Gabco Ltd. v. Minister of National
Revenue (1968), 68 D.T.C. 5210; Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336.
Statutes and Regulations Cited
Act to amend the Income Tax Act and to make certain provisions and alterations in the
statute law related to or consequential upon the amendments to that Act, S.C.
1970-71-72, c. 63, s. 1.
Act to amend the Income War Tax Act, S.C. 1939, c. 46, s. 13.
Income Tax Act, R.S.C. 1952, c. 148, ss. 17(3) [rep. 1970-71-72, c. 63, s. 1], 69(2)
[ad. idem].
Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .), ss. 20(1) (c)(i), 69(2) [rep. 1998, c. 19,
s. 107], 212(1)(d), 215(1), 247(2) [ad. idem, s. 238 ].
Income Tax Act, S.C. 1948, c. 52, s. 17(3).
Income Tax Amendments Act, 1997, S.C. 1998, c. 19, ss. 107, 238.
Income War Tax Act, R.S.C. 1927, c. 97, s. 23B [ad. 1939, c. 46, s. 13].
Patent Act Amendment Act, 1992, S.C. 1993, c. 2, s. 11(1).
Authors Cited
Organisation for Economic Co-operation and Development. Transfer Pricing and
Multinational Enterprises: Report of the OECD Committee on Fiscal Affairs. Paris:
The Organisation, 1979.
Organisation for Economic Co-operation and Development. Transfer Pricing Guidelines
for Multinational Enterprises and Tax Administrations. Paris: The Organisation,
1995.
APPEAL and CROSS-APPEAL from a judgment of the Federal Court of Appeal
(Nadon, Layden-Stevenson and Stratas JJ.A.), 2010 FCA 201, 405 N.R. 307, 2010 D.T.C.
5124, [2010] 6 C.T.C. 220, [2010] F.C.J. No. 953 (QL), 2010 CarswellNat 2409, setting
aside a decision of Rip A.C.J., 2008 TCC 324, 2008 D.T.C. 3957, [2008] T.C.J. No. 249 (QL),
2008 CarswellNat 1666. Appeal and cross-appeal dismissed.
Wendy Burnham, Eric Noble and Karen Janke-Curliss, for the
appellant/respondent on cross-appeal.
Al Meghji, Joseph M. Steiner, Amanda Heale and Pooja Samtani, for the
respondent/appellant on cross-appeal.
THE JUDGMENT OF THE COURT WAS DELIVERED BY
ROTHSTEIN J. —
I. Introduction
[1] Transfer pricing issues arise when entities of multinational
corporations resident in different jurisdictions transfer property or provide services to
one another. These entities do not deal at arm’s length and, thus, transactions between
these entities may not be subject to ordinary market forces. Their absence may result in
prices being set so as to divert profits from the appropriate tax jurisdiction. Since 1939,
the Income Tax Act has included provisions under which a Canadian taxpayer may be
reassessed to include, in Canadian profits, the difference between the prices for property
paid to a non-resident with which it does not deal at arm’s length and what those prices
would have been had they been dealing at arm’s length.
[2] The Minister of National Revenue reassessed GlaxoSmithKline
Inc. (“Glaxo Canada”) for the taxation years 1990, 1991, 1992, and 1993, pursuant to the
then-applicable s. 69(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp .) (the “Act ”),
on the basis that the prices Glaxo Canada paid to a supplier with which it did not deal at
arm’s length, for ranitidine, the active ingredient in the anti-ulcer drug Zantac, were
greater than an amount that would have been reasonable in the circumstances had they
been dealing at arm’s length. (Section 69(2) of the Act was repealed in 1998 (S.C. 1998,
c. 19, s. 107) and has been replaced by s. 247(2) of the Act (ad. idem, s. 238 )). The
reassessment increased Glaxo Canada’s income by the difference between the highest
price paid by generic pharmaceutical companies and that paid by Glaxo Canada for
ranitidine. Glaxo Canada appealed to the Tax Court of Canada, where Rip A.C.J. (as he
then was) upheld, with one minor revision, the reassessment. On Glaxo Canada’s further
appeal, the Federal Court of Appeal allowed the appeal and remitted the matter to the
Tax Court for reconsideration. The Minister has appealed that decision to this Court.
[3] The issue on appeal is the correct application of s. 69(2) : in particular,
what circumstances are to be taken into account in determining the reasonable arm’s
length price against which to compare the non-arm’s length transfer price. Glaxo Canada
cross-appeals the decision of the Federal Court of Appeal to remit the matter to the Tax
Court for rehearing and reconsideration. If this Court denies the Minister’s appeal, Glaxo
Canada argues that the matter should not be remitted because it has successfully
demolished the Minister’s assumptions, thus fully discharging the taxpayer’s burden in
appealing the reassessment. For the reasons that follow, I would dismiss both the appeal
and the cross-appeal.
II. Facts
[4] Between 1990 and 1993, the respondent, Glaxo Canada, purchased
ranitidine, the active pharmaceutical ingredient in the brand-name anti-ulcer drug
Zantac, from Adechsa S.A., a related non-resident company, for between $1,512 and
$1,651 per kilogram. During the same period, two Canadian generic pharmaceutical
companies, Apotex Inc. and Novopharm Ltd., purchased ranitidine from other sources for
use in their generic anti-ulcer drugs for between $194 and $304 per kilogram.
[5] At the relevant time Glaxo Canada was a wholly owned subsidiary of
Glaxo Group Ltd., which itself was a wholly owned subsidiary of Glaxo Holdings plc, a
United Kingdom corporation. In addition to its ownership of Glaxo Canada, Glaxo Group
was the parent of other companies, which discovered, developed, manufactured and
marketed branded pharmaceutical products. These products were then placed in a
delivery mechanism such as a tablet, liquid or gel and marketed and sold throughout the
world through subsidiaries such as Glaxo Canada or independent arm’s length
distributors.
[6] During the taxation years in issue, Glaxo Canada acted as a secondary
manufacturer and marketer which meant that it acquired the active pharmaceutical
ingredient, ranitidine, and put it into a delivery mechanism and packaged and marketed
Zantac, a patented and trademarked drug used to treat stomach ulcers. Glaxo Group
owned the Zantac trademark and the patent for its active ingredient, ranitidine, and
granted rights under the patent and trademark to Glaxo Canada under a Licence
Agreement. Glaxo Canada purchased ranitidine from Adechsa, a Glaxo Group clearing
company located in Switzerland, under a Supply Agreement.
[7] At the heart of this appeal are these two agreements. The Licence
Agreement conferred the following rights and benefits on Glaxo Canada:
1. the right under the patents to manufacture, use and sell Glaxo Group
products (s. 3(1)(a));
2. the exclusive right to the use of the trademarks owned by Glaxo
Group, including Zantac (s. 3(1)(b));
3. the right to receive technical assistance for its secondary
manufacturing requirements (s. 3(4));
4. the use of the registration materials prepared by Glaxo Group, to be
adapted to the Canadian environment and submitted to the Health
Protection Branch (s. 4(2));
5. access to new products, including line extensions (s. 4(1));
6. access to any inventions or improvement in regard to existing drugs
(s. 6(1));
7. the right to have a Glaxo World Group company sell to the appellant
any raw materials or materials in bulk form (s. 7(1));
8. marketing support in the form of promotional material, medical
papers and literature, market research data, and any other information
that may be useful in the marketing of products (s. 10(1));
9. indemnification against damages arising from patent or trademark
infringement actions (s. 13(2));
10. technical assistance for setting up new product lines at Glaxo Canada’s
manufacturing facilities (s. 4(3));
11. if the original trademark for a new product cannot be registered or if
additional trademarks are necessary, Glaxo Group to take the necessary
steps (s. 4(4));
12. Glaxo Canada to have an opportunity to sub-license any new third
party product obtained by Glaxo Group (s. 5(1));
13. in regard to third party products, Glaxo Group to provide any
information pertinent to the approval of the product by the Canada
Health Protection Branch (s. 5(2));
14. Glaxo Group to arrange that technical information in regard to third
party products will be granted to Glaxo Canada (s. 5(4)).
[8] Under the Supply Agreement, Glaxo Group set the transfer prices of
the active ingredient, ranitidine, using the resale-price method as described by Rip A.C.J.:
Glaxo World used what is referred to as a resale-price method to
determine the transfer price of the API [active pharmaceutical
ingredient]. Glaxo World and its distributors agreed that a gross margin
of 60 percent would be retained by the distributors and the ranitidine
was priced accordingly. To use a very simple example, if the ranitidine
product was sold for $10 in Italy, the transfer price would be $4; if the
ranitidine product was sold for $20 in France, the transfer price would be
$8. Appellant’s counsel described the process as follows:
the starting point for determining the price to the distributor was the in-
market price for the finished ranitidine product;
from that in-market price the parties agreed, assuming specified conditions
were satisfied, a gross profit margin [to] be retained by the
distributor (approximately 60%); and
the remainder would be remitted back to Glaxo Group in the form of transfer
price, royalties, [or both]. Where the distributor was to pay both
transfer prices and royalties, they would be considered together to
determine the distributor’s gross profit margin after payment of the
royalty. [para. 47]
(2008 TCC 325, 2008 D.T.C. 3957)
This method resulted in prices of over $1,500 per kilogram for ranitidine paid by Glaxo
Canada to Adechsa. The combined effect of the Licence and Supply agreements enabled
Glaxo Canada, among other things, to purchase the active ingredient ranitidine, put it in a
delivery mechanism, and market it under the trademark Zantac.
[9] During the taxation years in issue, two Canadian generic
pharmaceutical companies, Apotex and Novopharm, sold generic anti-ulcer
pharmaceutical products in Canada. These companies purchased ranitidine at lower
prices than Glaxo Canada, between $194 and $304 per kilogram, from arm’s length
suppliers. There was no evidence that the supply contracts of Apotex or Novopharm
conferred anything beyond the supply of ranitidine.
[10] These generic companies were able to market generic versions of
drugs whose patent was still in effect by reason of the compulsory licensing scheme that
existed for pharmaceutical products in Canada up to February 1993 (Patent Act
Amendment Act, 1992, S.C. 1993, c. 2). This scheme allowed generic versions of patented
pharmaceutical products to be marketed and sold in Canada in exchange for a royalty
payment to the patent owner. The licences granted to Apotex and Novopharm predated
December 20, 1991, and therefore continued to subsist, notwithstanding repeal of the
compulsory licensing scheme in February 1993 (ad. idem, s. 11(1)).
[11] The Minister reassessed Glaxo Canada for its 1990, 1991, 1992, and
1993 taxation years, increasing its income by some $51 million under s. 69(2) of
the Act on the basis that it had paid Adechsa more than a reasonable amount for the
purchase of ranitidine.
III. Tax Court of Canada, 2008 TCC 324, 2008 D.T.C. 3957 (Rip A.C.J.)
[12] Rip A.C.J. affirmed the Minister’s reassessment. He found that Singleton
v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046, required the Licence and Supply
agreements to be considered independently. As a result, he did not consider whether the
rights and benefits under the Licence Agreement were a relevant circumstance in
determining the appropriate arm’s length price for the supply of ranitidine.
[13] Rip A.C.J. employed the comparable uncontrolled price (“CUP”) method,
referred to in the Organisation for Economic Co-operation and Development
(“OECD”) Transfer Pricing and Multinational Enterprises: Report of the OECD Committee
on Fiscal Affairs (1979) (the “1979 Guidelines”) and the OECD’s revised 1995 Transfer
Pricing Guidelines for Multinational Enterprises and Tax Administrations(1995) (the
“1995 Guidelines”), to test the reasonableness of Glaxo Canada’s ranitidine
transactions. He found that the appropriate comparator transaction was the highest
price paid by the generic pharmaceutical companies for ranitidine from arm’s length
suppliers. Under this approach, he found the prices Glaxo Canada paid to Adechsa for
ranitidine were greater than the reasonable amount had they been dealing at arm’s
length. Aside from allowing a $25 per kilogram increment for granulation, he upheld the
reassessment of the Minister.
IV. Federal Court of Appeal, 2010 FCA 201, 405 N.R. 307 (Nadon, Layden-Stevenson
and Stratas JJ.A.)
[14] Nadon J.A., writing for a unanimous panel, found that the Tax Court had
erred in not considering the Licence Agreement when determining whether the prices
paid by Glaxo Canada for ranitidine were reasonable under s. 69(2) . He said
that Singleton was not relevant and that the test of “reasonable in the circumstances”
included all circumstances that an arm’s length purchaser would have to consider. Based
on Gabco Ltd. v. Minister of National Revenue (1968), 68 D.T.C. 5210 (Ex. Ct.), Nadon J.A.
adopted the “reasonable business person” test, which required an inquiry into the
circumstances that an arm’s length purchaser would consider relevant when deciding
what price to pay (para. 69). He found that Rip A.C.J. had erred when he assessed the
“fair market value” of ranitidine based on the amounts paid by the generic
pharmaceutical companies to arm’s length suppliers.
[15] Having determined that Singleton did not preclude looking at both the
Supply and Licence agreements and applying the “reasonable business person” test,
Justice Nadon found that the Licence Agreement was central to Glaxo Canada’s business
reality, and that it would be so even if the relationship with Adechsa was at arm’s
length. Therefore, it was a “circumstance” that had to be taken into account when
determining whether the prices paid by Glaxo Canada for ranitidine were reasonable. In
his view, the Tax Court erred in using the purchase prices of ranitidine of the generic
pharmaceutical companies to determine whether the Glaxo Canada prices were
reasonable, as the Licence Agreement created fundamentally different circumstances for
Glaxo Canada’s transactions.
[16] However, Nadon J.A. found that the burden on the taxpayer had not
been fully discharged as the “reasonable amount” remained to be determined for Glaxo
Canada’s ranitidine transactions. He remitted the matter to the Tax Court for
redetermination.
V. Analysis
A. Transfer Pricing in the Income Tax Act
[17] The first transfer pricing provision in the Canadian Income Tax Act was
enacted as s. 23B of the Income War Tax Act, R.S.C. 1927, c. 97, by An Act to amend the
Income War Tax Act, S.C. 1939, c. 46, s. 13. The provision was re-enacted as s. 17(3)
of The Income Tax Act, S.C. 1948, c. 52, and again as s. 17(3) of the Income Tax Act, R.S.C.
1952, c. 148. Section 17(3) of the 1952 Act is almost identical to s. 69(2) first enacted in
1971 (S.C. 1970-71-72, c. 63, s. 1), with immaterial modifications in 1985 (R.S.C. 1985, c.
1 (5th Supp .)).
[18] The 1985 version of s. 69(2) applicable to the years 1990-1993 reads:
(2) Where a taxpayer has paid or agreed to pay to a non-resident
person with whom the taxpayer was not dealing at arm’s length as price,
rental, royalty or other payment for or for the use or reproduction of any
property, or as consideration for the carriage of goods or passengers or
for other services, an amount greater than the amount (in this subsection
referred to as “the reasonable amount”) that would have been reasonable
 in the circumstances if the non-resident person and the taxpayer had
been dealing at arm’s length, the reasonable amount shall, for the purpose
of computing the taxpayer’s income under this Part, be deemed to have
been the amount that was paid or is payable therefor.
[19] On the facts of this case, the section asks whether the prices Glaxo
Canada paid Adechsa for ranitidine were greater than what would have been reasonable
if Adechsa and Glaxo Canada had been dealing at arm’s length. The challenge is to find an
arm’s length proxy that replicates the circumstances of Glaxo Canada as closely as
possible in respect of its acquisition of ranitidine.
B. The OECD Methods of Determining Reasonable Transfer Prices
[20] In the courts below and in this Court, there has been reference to the
1979 Guidelines and the 1995 Guidelines (the “Guidelines”). The Guidelines contain
commentary and methodology pertaining to the issue of transfer pricing. However,
the Guidelines are not controlling as if they were a Canadian statute and the test of any
set of transactions or prices ultimately must be determined according to s. 69(2) rather
than any particular methodology or commentary set out in the Guidelines.
[21] Section 69(2) does not, itself, offer guidance as to how to determine
the “reasonable amount” that would have been payable had the parties been dealing at
arm’s length. However, the Guidelinessuggest a number of methods for determining
whether transfer prices are consistent with prices determined between parties dealing
at arm’s length.
[22] In the Tax Court, the parties relied on four methods from
the Guidelines to assess the reasonableness of the prices Glaxo Canada paid Adechsa. The
Minister relied on the CUP method and the cost plus method (see 1979 Guidelines, at
paras. 48 and 63). The CUP method compares the prices in comparable transactions
between parties dealing at arm’s length with the transfer prices paid by the taxpayer
being reassessed. The Guidelines say this is the most direct way of determining the arm’s
length price. This is the method under which the Minister compared the Glaxo Canada
transfer prices with the prices paid by Apotex and Novopharm.
[23] However, the 1995 Guidelines also say that the arm’s length
transactions must be carefully considered for comparability with the transfer price
transactions. Transactions are only comparable if:
1. None of the differences (if any) between the transactions being compared or
between the enterprises undertaking those transactions could materially affect
the price in the open market; or
2. Reasonably accurate adjustments can be made to eliminate the material effects of
such differences. (See 1995 Guidelines, at para. 1.15.)
[24] The cost plus method is based upon the foreign suppliers’ costs, plus an
appropriate mark-up. However, the 1979 Guidelines say that the method “raise[d]
problems both as regards assessing costs . . . and the appropriate mark-up for profit”
(para. 63). They suggest its usefulness may be as a means of verifying prices after other
methods have been applied. The Minister used the cost plus method to verify the arm’s
length prices he determined under the CUP method.
[25] Glaxo Canada relied on the resale price, the transactional net margin
and the CUP methods, using a set of European comparators. As described above, the
resale-price method starts with the price charged by the reseller (Glaxo Canada) in the
market for the product (Zantac). The price is then reduced by the proportion
representing the reseller’s cost and appropriate profit, i.e. the reseller’s gross profit
margin. The balance is the transfer price for the product purchased from the related
non-resident supplier (Adechsa). This gross profit margin is then compared to the gross
profit margin earned by independent arm’s length resellers. The
1979 Guidelines observe that this method is the most useful when applied to marketing
operations. Glaxo Canada compared its gross profit margin with those of independent
European distributors of Zantac.
[26] The transactional net margin method looks at the net profit relative to
a base such as costs, sales or assets in a controlled transaction as compared to the net
profit ratio earned by the same taxpayer in comparable uncontrolled transactions. If this
is not possible, consideration may be given to the net profit relative to costs, sales or
assets of an independent enterprise, provided the circumstances are comparable and
adjustments may be made to obtain reliable results.
[27] Glaxo Canada’s CUP approach utilized the prices paid by European
independent distributors of Zantac which Glaxo Canada submitted approximated the
prices paid by Glaxo Canada to Adechsa.
C. The Transactional Approach Adopted by the Tax Court
[28] Rip A.C.J. rejected Glaxo Canada’s evidence and submissions. Utilizing
the CUP method, Rip A.C.J. compared the prices paid by Glaxo Canada with those paid by
the Canadian generic companies for ranitidine and found that the highest generic prices
paid were in the range of $300 per kilogram, while Glaxo Canada was paying over $1,500
per kilogram.
[29] Glaxo Canada had argued that the comparison with generic companies
was inappropriate. It said that the Licence Agreement must be taken into account, as it
conferred certain rights and benefits related to the purpose for which its ranitidine was
purchased.
[30] However, Rip A.C.J. found that Singleton precluded him from
considering the Licence Agreement. Absent the Licence Agreement, the prices paid
under the Supply Agreement had to be considered as being only for ranitidine. There
could thus be no compensation for other rights or benefits under the Supply Agreement.
Because the prices paid by Glaxo Canada and the generic companies were both solely for
ranitidine, there were no differences between the transactions that might justify higher
transfer prices than the prices paid by Apotex and Novopharm (aside from a $25 per
kilogram charge for granulation that Glaxo Canada was allowed).
[31] The question before Rip A.C.J. was the determination of the reasonable
price under s. 69(2) . Critical to that determination was whether the Licence Agreement
was a circumstance to be taken into account.
[32] The Minister argues that this Court’s decisions in Singleton and Shell
Canada Ltd. v. Canada,[1999] 3 S.C.R. 622, along with the Guidelines, require a
transactional, sometimes called a transaction-by-transaction, approach when
determining the reasonable transfer price under s. 69(2) . In the Tax Court, the Minister
explained that the transaction-by-transaction approach is one in which the transaction in
issue must be considered independently from surrounding circumstances, other
transactions, or other realities. In this Court, the Minister submitted that “each transfer
is to be treated as a separate transaction” (A.F., at para. 46). Accordingly, the Licence
Agreement would be irrelevant.
(1) Singleton
[33] The Minister submits that Singleton and Shell, decided
under s. 20(1) (c)(i) of the Act , are authority for the proposition that a transaction-by-
transaction approach must be followed under s. 69(2) . Singleton involved the
deductibility from income of interest paid and payable on borrowed money under s.
20(1) (c)(i), of the Income Tax Act . In Singleton, the taxpayer used funds from his capital
account at his law firm to assist in financing the purchase of a home. He then used
borrowed funds to replace the funds he was withdrawing from his capital account. The
sole issue was whether borrowed money was “used for the purpose of earning
income”. This Court found that the borrowed funds were used to invest in the law firm
for the purpose of earning income and, therefore, the interest payable thereon was
deductible for income tax purposes. The fact that the borrowing occurred because the
taxpayer wanted to use his equity in the firm to buy a house was irrelevant for
determining the use of the borrowed funds. For purposes of s. 20(1) (c)(i), it would be
wrong to collapse the transaction withdrawing funds from the firm to purchase the
house and the borrowing transaction to replenish the capital account at the firm. It was
the requirement to treat the two transactions separately that caused Rip A.C.J., at para.
78, to say that s. 69(2) required the Supply and Licence agreements to be treated
separately.
[34] With respect, the approach of the Tax Court judge and the argument of
the Minister ignore the difference between s. 20(1) (c)(i) and s. 69(2) . Nothing in s.
20(1) (c)(i) entitles a court to search for anything other than the use to which the
borrowed funds are put. The factual determination is simply whether the use of
borrowed funds was for the purpose of earning income.
[35] Section 20(1) (c)(i) does not ask whether it is unreasonable to claim
the interest deduction; nor does it require a comparison of transactions to determine if
the deduction is reasonable. By contrast, s. 69(2) requires the court to determine
whether the transfer price was greater than the amount that would have been
reasonable in the circumstances, had the parties been dealing at arm’s length. If
transactions other than the purchasing transaction are relevant in determining this
question, they must not be ignored.
 (2) Shell
[36] The issue in Shell similarly involved s. 20(1) (c)(i). Again the issue
involved whether borrowed funds were used for the purpose of earning income. In Shell,
the taxpayer had entered into an agreement to borrow $150 million in New Zealand
currency at an interest rate of 15.4 percent. The taxpayer converted these funds into U.S.
currency, which was then used for business purposes. Through a series of foreign
currency transactions relating to the devaluation of the New Zealand currency over the
course of the loan, Shell was able to reduce its effective rate of interest to 9.1 percent,
while still claiming an income tax deduction based on the 15.4 percent interest rate on
the initial transaction.
[37] The issue in Shell, as in Singleton, turned on whether the borrowed
funds, once converted into U.S. currency, could properly be considered to be used for the
purpose of earning income. The Court found that it was irrelevant that the funds had
been converted into U.S. currency as part of a sophisticated tax scheme. The Minister
was not entitled to re-characterize the taxpayer’s bona fide legal relationships.
[38] This differs significantly from s. 69(2) . The requirement of s. 69(2) is
that the price established in a non-arm’s length transfer pricing transaction is to be
redetermined as if it were between parties dealing at arm’s length. If the circumstances
require, transactions other than the purchasing transactions must be taken into account
to determine whether the actual price was or was not greater than the amount that
would have been reasonable had the parties been dealing at arm’s length. Shell is
therefore also inapplicable to a determination under s. 69(2) .
(3) Guidelines Do Not Require a Transaction-by-Transaction Approach
[39] The Minister also relied on para. 1.42 of the 1995 Guidelines to justify
the transaction-by-transaction requirement. Paragraph 1.42 provides:
Ideally, in order to arrive at the most precise approximation of fair market
value, the arm’s length principle should be applied on a transaction-by-
transaction basis.
The Minister submits that para. 1.42 requires the court to focus only on the particular
transaction at issue and, thus, does not permit the Licence Agreement to inform the
determination of the reasonableness of the prices paid for ranitidine under the Supply
Agreement.
[40] However, para. 1.42 is not as restrictive as the Minister submits. It also
provides:
. . . there are often situations where separate transactions are so closely linked
or continuous that they cannot be evaluated adequately on a separate
basis.
Thus, while a transaction-by-transaction approach may be ideal, the
1995 Guidelines themselves recognize that it is not appropriate in all cases.
[41] Further, the general statement in the 1995 Guidelines regarding the
arm’s length principle at para. 1.15 also provides guidance as to when related
transactions should be taken into account:
Application of the arm’s length principle is generally based on a
comparison of the conditions in a controlled transaction with the
conditions in transactions between independent enterprises. In order for
such comparisons to be useful, the economically relevant characteristics
of the situations being compared must be sufficiently comparable. To be
comparable means that none of the differences (if any) between the
situations being compared could materially affect the condition being
examined in the methodology (e.g. price or margin), or that reasonably
accurate adjustments can be made to eliminate the effect of any such
differences. [Emphasis added.]
[42] Thus, according to the 1995 Guidelines, a proper application of the
arm’s length principle requires that regard be had for the “economically relevant
characteristics” of the arm’s length and non-arm’s length circumstances to ensure they
are “sufficiently comparable”. Where there are no related transactions or where related
transactions are not relevant to the determination of the reasonableness of the price in
issue, a transaction-by-transaction approach may be appropriate. However,
“economically relevant characteristics of the situations being compared” may make it
necessary to consider other transactions that impact the transfer price under
consideration. In each case, it is necessary to address this question by considering the
relevant circumstances.
D. The Licence Agreement Is Relevant in the Circumstances
[43] For the above reasons, in my respectful opinion, Rip A.C.J. was in error
when he found that he was precluded from considering the Licence
Agreement. Nonetheless, while consideration of the Licence Agreement was not
precluded, the question still remains as to whether he should have considered it.
[44] Because s. 69(2) requires an inquiry into the price that would be
reasonable in the circumstances had the non-resident supplier and the Canadian
taxpayer been dealing at arm’s length, it necessarily involves consideration of all the
circumstances of the Canadian taxpayer relevant to the price paid to the non-resident
supplier. Such circumstances will include agreements that may confer rights and
benefits in addition to the purchase of property where those agreements are linked to
the purchasing agreement. The objective is to determine what an arm’s length purchaser
would pay for the property and the rights and benefits together where the rights and
benefits are linked to the price paid for the property.
[45] The business of Glaxo Canada was the secondary manufacturing and
marketing of brand-name pharmaceuticals, including Zantac. Glaxo Canada also engaged
in research and development although there is no indication that its research and
development work pertained to Zantac. Glaxo Canada’s purchase of ranitidine must be
understood, having regard to this business reality.
[46] Rip A.C.J. found, at para. 86, that “it was by virtue of the Licence
Agreement that the appellant was required to purchase its ranitidine from Glaxo
approved sources”. The parties have not disputed this finding.
[47] There were only two approved sources, one of which was
Adechsa. Thus, in order to avail itself of the benefits of the Licence Agreement, Glaxo
Canada was required to purchase the active ingredient from one of these sources. This
requirement was not the product of the non-arm’s length relationship between Glaxo
Canada and Glaxo Group or Adechsa. Rather, it arose because Glaxo Group controlled the
trademark and patent of the brand-name pharmaceutical product Glaxo Canada wished
to market. An arm’s length distributor wishing to market Zantac might well be faced with
the same requirement.
[48] The effect of the link between the Licence and Supply agreements was
that an entity that wished to market Zantac was subject to contractual terms affecting
the price of ranitidine that generic marketers of ranitidine products were not.
[49] As such, the rights and benefits of the Licence Agreement were
contingent on Glaxo Canada entering into a Supply Agreement with suppliers to be
designated by Glaxo Group. The result of the price paid was to allocate to Glaxo Canada
what Glaxo Group considered to be appropriate compensation for its secondary
manufacturing and marketing function in respect of ranitidine and Zantac.
[50] Rip A.C.J. appears to have been concerned that a multinational
organization, by requiring a Canadian subsidiary to acquire a product from a specified
supplier, would escape the requirement to have its prices measured against arm’s length
prices (para. 89). However, whatever price was determined by Glaxo Group would be
subject to s. 69(2) and the requirement that the transfer pricing transactions be
measured against transactions between parties dealing with each other at arm’s length.
[51] Thus, it appears that Glaxo Canada was paying for at least some of the
rights and benefits under the Licence Agreement as part of the purchase prices for
ranitidine from Adechsa. Because the prices paid to Adechsa were set, in part, as
compensation to Glaxo Group for the rights and benefits conferred on Glaxo Canada
under the Licence Agreement, the Licence Agreement could not be ignored in
determining the reasonable amount paid to Adechsa under s. 69(2), which applies not
only to payment for goods but also to payment for services.
[52] Considering the Licence and Supply agreements together offers a
realistic picture of the profits of Glaxo Canada. It cannot be irrelevant that Glaxo
Canada’s function was primarily as a secondary manufacturer and marketer. It did not
originate new products and the intellectual property rights associated with them. Nor
did it undertake the investment and risk involved with originating new products. Nor
did it have the other risks and investment costs which Glaxo Group undertook under the
Licence Agreement. The prices paid by Glaxo Canada to Adechsa were a payment for a
bundle of at least some rights and benefits under the Licence Agreement and product
under the Supply Agreement.
[53] I agree with the Federal Court of Appeal that Rip A.C.J. erred in refusing
to take account of the Licence Agreement. It was that refusal which led him to find that
the prices the generic pharmaceutical companies paid for ranitidine were comparable
under the CUP method. However, the generic comparators do not reflect the economic
and business reality of Glaxo Canada and, at least without adjustment, do not indicate the
price that would be reasonable in the circumstances, had Glaxo Canada and Adechsa
been dealing at arm’s length.
[54] I agree with Justice Nadon that “the amount that would have been
reasonable in the circumstances” if Glaxo Canada and Adechsa had been dealing at arm’s
length has yet to be determined (para. 79). This will require a close examination of the
terms of the Licence Agreement and the rights and benefits granted to Glaxo Canada
under that Agreement.
[55] However, with respect to royalties, I would observe that the Licence
Agreement expressly provides under clause 11(1)(b):
(ii) in the event that GLAXO CANADA purchases raw materials or bulk or
finished Product from GROUP or an Associate it is the parties’
express intention that no royalties be payable by GLAXO
CANADA on the importation of such raw materials or bulk or
finished Product but only on GLAXO CANADA’s Net Sales of
Product in the Territory;
(iii) GLAXO CANADA shall not be required to pay any royalty or license fee
as a condition of the sale by GROUP or its Associates to GLAXO
CANADA of merchandise for export to the Territory and such
merchandise shall be priced in accordance with a separate
agreement between the parties without regard to royalties
payable hereunder [as contemplated in sub-clause 7(1) hereof]
(iv) no royalty shall be payable by GLAXO CANADA on its manufacture or
use of the Products but only on its sales of the Products; [Text in
brackets in original.]
[56] Glaxo Canada’s pleadings in the Tax Court did not rely on s. 212(1) (d)
or s. 215(1) of the Act , which provide for tax payable by non-residents on royalties or
similar payments for the right to use any patent or trademark in Canada and for
withholding tax on behalf of the non-resident. There is no evidence that Glaxo Canada
withheld any amounts of the prices it paid to Adechsa in respect of royalties for the use
or the right to use the ranitidine patent or Zantac trademark.
[57] Although I said above that the purchase price appeared to be linked to
some of the rights and benefits conferred under the Licence Agreement, I make no
determination in these reasons as to whether the rights under the ranitidine patent
granted to Glaxo Canada to manufacture and sell Zantac and the exclusive right to use the
Zantac trademark are linked to the purchase price paid by Glaxo Canada to
Adechsa. However, arguably, if the purchase price includes compensation for intellectual
property rights granted to Glaxo Canada, there would have to be consistency between
that and Glaxo Canada’s position with respect to Part XIII withholding tax. This issue
was not specifically argued in this Court and may be addressed by the parties in the Tax
Court and considered by the Tax Court judge when considering whether any specific
rights and benefits conferred on Glaxo Canada under the Licence Agreement are linked
to the price for ranitidine paid to Adechsa.
[58] In any event, there are rights and benefits under the Licence
Agreement referred to in para. 7 above, other than the patent and trademark rights
granted to Glaxo Canada. For example, guaranteed access to new products, the right to
the supply of raw materials and materials in bulk, marketing support, and technical
assistance for setting up new product lines all appear to have some value.
[59] In addition, while, as Rip A.C.J. found, Glaxo Canada’s ranitidine and
generic ranitidine are chemically equivalent and bio-equivalent, he also found that there
was value in the fact that Adechsa’s ranitidine manufactured under Glaxo Group’s “good
manufacturing practices” “may confer a certain degree of comfort that the good has
minimal impurities and is manufactured in a responsible manner” (para. 118). Zantac is
priced higher than the generic products, presumably, at least in part, because of that
“degree of comfort” that Rip A.C.J. acknowledged.
[60] These are all features of the Licence Agreement and the requirement to
purchase from a Glaxo-approved source that add value to the ranitidine that Glaxo
Canada purchased from Adechsa over and above the value of generic ranitidine without
these rights and benefits. They should justify some recognition in determining what an
arm’s length purchaser would be prepared to pay for the same rights and benefits
conveyed with ranitidine purchased from a Glaxo Group source. It is only after
identifying the circumstances arising from the Licence Agreement that are linked to the
Supply Agreement that arm’s length comparisons under any of the OECD methods or
other methods may be determined.
[61] I would offer the following additional guidance with respect to the
redetermination. First, s. 69(2) uses the term “reasonable amount”. This reflects the fact
that, to use the words of the 1995 Guidelines, “transfer pricing is not an exact science”
(para. 1.45). It is doubtful that comparators will be identical in all material respects in
almost any case. Therefore, some leeway must be allowed in the determination of the
reasonable amount. As long as a transfer price is within what the court determines is a
reasonable range, the requirements of the section should be satisfied. If it is not, the
court might select a point within a range it considers reasonable in the circumstances
based on an average, median, mode, or other appropriate statistical measure, having
regard to the evidence that the court found to be relevant. I repeat for emphasis that it is
highly unlikely that any comparisons will yield identical circumstances and the Tax Court
judge will be required to exercise his best informed judgment in establishing a
satisfactory arm’s length price.
[62] Second, while assessment of the evidence is a matter for the trial judge,
I would observe that the respective roles and functions of Glaxo Canada and the Glaxo
Group should be kept in mind. Glaxo Canada engaged in the secondary manufacturing
and marketing of Zantac. Glaxo Group is the owner of the intellectual property and
provided other rights and benefits to Glaxo Canada. Transfer pricing should not result in
a misallocation of earnings that fails to take account of these different functions and the
resources and risks inherent in each. As discussed above, whether or not compensation
for intellectual property rights is justified in this particular case is a matter for
determination by the Tax Court judge.
[63] Third, prices between parties dealing at arm’s length will be
established having regard to the independent interests of each party to the
transaction. That means that the interests of Glaxo Group and Glaxo Canada must both
be considered. An appropriate determination under the arm’s length test of s. 69(2)
should reflect these realities.
[64] Fourth, in this case, there is some evidence that indicates that arm’s
length distributors have found it in their interest to acquire ranitidine from a Glaxo
Group supplier, rather than from generic sources. This suggests that higher-than-generic
transfer prices are justified and are not necessarily greater than a reasonable amount
under s. 69(2).
[65] I would dismiss the appeal, and for the reasons below, dismiss the
cross-appeal and remit the matter to Rip A.C.J. (now Chief Justice) for redetermination.
VI. Cross-Appeal
[66] Glaxo Canada cross-appeals, arguing that the decision of the Federal
Court of Appeal to remit the matter to the Tax Court for redetermination should be
overturned. It asks this Court to set aside the reassessment on the basis that it has
satisfied its burden as a taxpayer because it has “demolished” the assumptions of the
Minister.
[67] The Federal Court of Appeal remitted the matter to the Tax Court on
the basis that Glaxo Canada had not discharged its burden of demonstrating that the
prices it paid Adechsa for ranitidine were reasonable under s. 69(2):
As a result, I conclude that the Judge erred in law in failing to apply the
proper test in determining “the amount that would have been reasonable
in the circumstances” if the appellant and Adechsa had been dealing at
arm’s length. Counsel for the appellant argued that in the event that we
agreed with him that the Judge erred in not considering the License
Agreement, we should then determine “the reasonable amount”. In my
view, that determination ought to be made by the Judge, who heard the
parties for well over forty days, and not by this Court. [para. 82]
The Federal Court of Appeal declined to make such a determination on the basis that it
could not properly assess the adequacy of the record on this point and remitted the
matter to the Tax Court judge to consider whether a decision can be made on the basis of
the existing record or whether additional evidence is necessary.
[68] Glaxo Canada argues that the choice of the generic comparator
transactions by the Minister constitutes the basis of the Minister’s
assessment. Therefore, the burden on Glaxo Canada was only to demonstrate that the
transactions of the generic pharmaceutical companies were not the proper
comparator. In Glaxo Canada’s view, such a finding would demolish the basis of the
assessment, thus, discharging its burden.
[69] The Minister argues that the basis of the assessment was the
determination that the prices Glaxo Canada paid for ranitidine were not reasonable. The
selection of the generic comparators was only a means which the Minister had chosen to
demonstrate the unreasonableness.
[70] The basis of the assessment is found in the assumptions in the
Minister’s Amended Reply to Glaxo Canada’s Amended Notice of Appeal. Assumptions
14p) and r.A) provide:
p) the Appellant paid Adechsa, with whom it was not dealing at arm’s
length, a price for ranitidine which was greater than the amount
that would have been reasonable in the circumstances if the
Appellant and Adechsa had been dealing at arm’s length;
r.A) any amounts paid by the appellant to Adechsa over and above the prices
paid by other Canadian pharmaceutical companies (as detailed in
Schedule A attached) were not for the supply of ranitidine;
[74] As it stands, the assumption that the prices paid by Glaxo Canada for
ranitidine were greater than the amount that would have been reasonable in the
circumstances, had Glaxo Canada and Adechsa been dealing at arm’s length, has not been
demolished. Therefore, assumption 14p) remains standing.
[75] At the Federal Court of Appeal, Glaxo Canada argued that that court
could determine “the reasonable amount”. If the Federal Court of Appeal could
determine the reasonable amount, I cannot see why it could not remit the matter to the
Tax Court for that very determination.
[76] Like the Federal Court of Appeal, I would remit the matter to the Tax
Court to be redetermined, having regard to the effect of the Licence Agreement on the
prices paid by Glaxo Canada for the supply of ranitidine from Adechsa. The Tax Court
judge should consider any new evidence the parties seek to adduce and that he may
choose to allow.

[71] Glaxo Canada argues, in effect, that only assumption 14r.A) constitutes VII. Conclusion
the basis of the assessment and that it has demolished that assumption. The Minister
argues that the basis of the assessment is assumption 14p). The text of the assumptions
supports the position of the Minister. Here assumption 14p) sets out the statutory basis [77] I would dismiss the appeal with costs throughout; dismiss the cross-
for the reassessment, placing the reassessment squarely under s. 69(2). The taxpayer’s appeal with costs in this Court and remit the matter to the Tax Court for
liability is governed by the Act and the Minister’s authority to reassess arises from redetermination.
invoking a particular provision or provisions of the Act .

Appeal and cross-appeal dismissed with costs.

[72] In Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336, Justice
L’Heureux-Dubé states that the taxpayer’s burden is to “‘demolish’ the exact assumptions
made by the Minister but no more” (para. 92 (emphasis deleted)). Here, it is safe to say Solicitor for the appellant/respondent on cross-appeal: Attorney General of
that assumption 14r.A) by the Minister of the prices paid by Apotex and Novopharm as Canada, Ottawa.
CUP transactions, without adjustments, was indeed demolished. However, assumption
14p) was not.
Solicitors for the respondent/appellant on cross-appeal: Osler, Hoskin &
Harcourt, Toronto.
[73] Indeed, at the Tax Court, Glaxo Canada sought to establish the
reasonableness of the prices it paid, though its evidence and argument were not
accepted by the Tax Court judge. In other words, it accepted the burden of
demonstrating that the prices it paid were reasonable within the meaning of s.
69(2). Had it been successful in establishing that the prices it paid were reasonable,
assumption 14p) as well as 14r.A), would have been demolished.