G.R. No.

L-65773-74 April 30, 1987

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
BRITISH OVERSEAS AIRWAYS CORPORATION and COURT OF TAX APPEALS,
respondents.

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

MELENCIO-HERRERA, J.:

Petitioner Commissioner of Internal Revenue (CIR) seeks a review on certiorari of the joint
Decision of the Court of Tax Appeals (CTA) in CTA Cases Nos. 2373 and 2561, dated 26
January 1983, which set aside petitioner's assessment of deficiency income taxes against
respondent British Overseas Airways Corporation (BOAC) for the fiscal years 1959 to 1967,
1968-69 to 1970-71, respectively, as well as its Resolution of 18 November, 1983 denying
reconsideration.

BOAC is a 100% British Government-owned corporation organized and existing under the laws
of the United Kingdom It is engaged in the international airline business and is a member-
signatory of the Interline Air Transport Association (IATA). As such it operates air transportation
service and sells transportation tickets over the routes of the other airline members. During the
periods covered by the disputed assessments, it is admitted that BOAC had no landing rights for
traffic purposes in the Philippines, and was not granted a Certificate of public convenience and
necessity to operate in the Philippines by the Civil Aeronautics Board (CAB), except for a nine-
month period, partly in 1961 and partly in 1962, when it was granted a temporary landing permit
by the CAB. Consequently, it did not carry passengers and/or cargo to or from the Philippines,
although during the period covered by the assessments, it maintained a general sales agent in
the Philippines — Wamer Barnes and Company, Ltd., and later Qantas Airways — which was
responsible for selling BOAC tickets covering passengers and cargoes. 1

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

On 7 May 1968, petitioner Commissioner of Internal Revenue (CIR, for brevity) assessed BOAC
the aggregate amount of P2,498,358.56 for deficiency income taxes covering the years 1959 to
1963. This was protested by BOAC. Subsequent investigation resulted in the issuance of a new
assessment, dated 16 January 1970 for the years 1959 to 1967 in the amount of P858,307.79.
BOAC paid this new assessment under protest.

On 7 October 1970, BOAC filed a claim for refund of the amount of P858,307.79, which claim
was denied by the CIR on 16 February 1972. But before said denial, BOAC had already filed a
petition for review with the Tax Court on 27 January 1972, assailing the assessment and praying
for the refund of the amount paid.

G.R. No. 65774 (CTA Case No. 2561, the Second Case)
On 17 November 1971, BOAC was assessed deficiency income taxes, interests, and penalty for
the fiscal years 1968-1969 to 1970-1971 in the aggregate amount of P549,327.43, and the
additional amounts of P1,000.00 and P1,800.00 as compromise penalties for violation of
Section 46 (requiring the filing of corporation returns) penalized under Section 74 of the National
Internal Revenue Code (NIRC).

On 25 November 1971, BOAC requested that the assessment be countermanded and set
aside. In a letter, dated 16 February 1972, however, the CIR not only denied the BOAC request
for refund in the First Case but also re-issued in the Second Case the deficiency income tax
assessment for P534,132.08 for the years 1969 to 1970-71 plus P1,000.00 as compromise
penalty under Section 74 of the Tax Code. BOAC's request for reconsideration was denied by
the CIR on 24 August 1973. This prompted BOAC to file the Second Case before the Tax Court
praying that it be absolved of liability for deficiency income tax for the years 1969 to 1971.

This case was subsequently tried jointly with the First Case.

On 26 January 1983, the Tax Court rendered the assailed joint Decision reversing the CIR. The
Tax Court held that the proceeds of sales of BOAC passage tickets in the Philippines by Warner
Barnes and Company, Ltd., and later by Qantas Airways, during the period in question, do not
constitute BOAC income from Philippine sources "since no service of carriage of passengers or
freight was performed by BOAC within the Philippines" and, therefore, said income is not
subject to Philippine income tax. The CTA position was that income from transportation is
income from services so that the place where services are rendered determines the source.
Thus, in the dispositive portion of its Decision, the Tax Court ordered petitioner to credit BOAC
with the sum of P858,307.79, and to cancel the deficiency income tax assessments against
BOAC in the amount of P534,132.08 for the fiscal years 1968-69 to 1970-71.

Hence, this Petition for Review on certiorari of the Decision of the Tax Court.

The Solicitor General, in representation of the CIR, has aptly defined the issues, thus:

1. Whether or not the revenue derived by private respondent British Overseas

Airways Corporation (BOAC) from sales of tickets in the Philippines for air
transportation, while having no landing rights here, constitute income of BOAC
from Philippine sources, and, accordingly, taxable.

2. Whether or not during the fiscal years in question BOAC s a resident foreign
corporation doing business in the Philippines or has an office or place of
business in the Philippines.

3. In the alternative that private respondent may not be considered a resident

foreign corporation but a non-resident foreign corporation, then it is liable to
Philippine income tax at the rate of thirty-five per cent (35%) of its gross income
received from all sources within the Philippines.

Under Section 20 of the 1977 Tax Code:

(h) the term resident foreign corporation engaged in trade or business within the
Philippines or having an office or place of business therein.
 (i) The term "non-resident foreign corporation" applies to a foreign corporation not
engaged in trade or business within the Philippines and not having any office or
place of business therein

It is our considered opinion that BOAC is a resident foreign corporation. There is no specific
criterion as to what constitutes "doing" or "engaging in" or "transacting" business. Each case
must be judged in the light of its peculiar environmental circumstances. The term implies a
continuity of commercial dealings and arrangements, and contemplates, to that extent, the
performance of acts or works or the exercise of some of the functions normally incident to, and
in progressive prosecution of commercial gain or for the purpose and object of the business
organization. 2 "In order that a foreign corporation may be regarded as doing business within a
State, there must be continuity of conduct and intention to establish a continuous business,
such as the appointment of a local agent, and not one of a temporary character. 3

BOAC, during the periods covered by the subject - assessments, maintained a general sales
agent in the Philippines, That general sales agent, from 1959 to 1971, "was engaged in (1)
selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in the
series corresponding to a different airline company; (3) receiving the fare from the whole trip;
and (4) consequently allocating to the various airline companies on the basis of their
participation in the services rendered through the mode of interline settlement as prescribed by
Article VI of the Resolution No. 850 of the IATA Agreement." 4 Those activities were in exercise
of the functions which are normally incident to, and are in progressive pursuit of, the purpose
and object of its organization as an international air carrier. In fact, the regular sale of tickets, its
main activity, is the very lifeblood of the airline business, the generation of sales being the
paramount objective. There should be no doubt then that BOAC was "engaged in" business in
the Philippines through a local agent during the period covered by the assessments.
Accordingly, it is a resident foreign corporation subject to tax upon its total net income received
in the preceding taxable year from all sources within the Philippines. 5

Sec. 24. Rates of tax on corporations. — ...

(b) Tax on foreign corporations. — ...

(2) Resident corporations. — A corporation organized, authorized, or existing

under the laws of any foreign country, except a foreign fife insurance company,
engaged in trade or business within the Philippines, shall be taxable as provided
in subsection (a) of this section upon the total net income received in the
preceding taxable year from all sources within the Philippines. (Emphasis
supplied)

Next, we address ourselves to the issue of whether or not the revenue from sales of tickets by
BOAC in the Philippines constitutes income from Philippine sources and, accordingly, taxable
under our income tax laws.

The Tax Code defines "gross income" thus:

"Gross income" includes gains, profits, and income derived from salaries, wages
or compensation for personal service of whatever kind and in whatever form
paid, or from profession, vocations, trades, business, commerce, sales, or
dealings in property, whether real or personal, growing out of the ownership or
 use of or interest in such property; also from interests, rents, dividends,
securities, or the transactions of any business carried on for gain or profile, or
gains, profits, and income derived from any source whatever (Sec. 29[3];
Emphasis supplied)

The definition is broad and comprehensive to include proceeds from sales of transport
documents. "The words 'income from any source whatever' disclose a legislative policy to
include all income not expressly exempted within the class of taxable income under our laws."
Income means "cash received or its equivalent"; it is the amount of money coming to a person
within a specific time ...; it means something distinct from principal or capital. For, while capital is
a fund, income is a flow. As used in our income tax law, "income" refers to the flow of wealth. 6

The records show that the Philippine gross income of BOAC for the fiscal years 1968-69 to
1970-71 amounted to P10,428,368 .00. 7

Did such "flow of wealth" come from "sources within the Philippines",

The source of an income is the property, activity or service that produced the income. 8 For the
source of income to be considered as coming from the Philippines, it is sufficient that the
income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the
Philippines is the activity that produces the income. The tickets exchanged hands here and
payments for fares were also made here in Philippine currency. The site of the source of
payments is the Philippines. The flow of wealth proceeded from, and occurred within, Philippine
territory, enjoying the protection accorded by the Philippine government. In consideration of
such protection, the flow of wealth should share the burden of supporting the government.

A transportation ticket is not a mere piece of paper. When issued by a common carrier, it
constitutes the contract between the ticket-holder and the carrier. It gives rise to the obligation of
the purchaser of the ticket to pay the fare and the corresponding obligation of the carrier to
transport the passenger upon the terms and conditions set forth thereon. The ordinary ticket
issued to members of the traveling public in general embraces within its terms all the elements
to constitute it a valid contract, binding upon the parties entering into the relationship. 9

True, Section 37(a) of the Tax Code, which enumerates items of gross income from sources
within the Philippines, namely: (1) interest, (21) dividends, (3) service, (4) rentals and royalties,
(5) sale of real property, and (6) sale of personal property, does not mention income from the
sale of tickets for international transportation. However, that does not render it less an income
from sources within the Philippines. Section 37, by its language, does not intend the
enumeration to be exclusive. It merely directs that the types of income listed therein be treated
as income from sources within the Philippines. A cursory reading of the section will show that it
does not state that it is an all-inclusive enumeration, and that no other kind of income may be so
considered. " 10

BOAC, however, would impress upon this Court that income derived from transportation is
income for services, with the result that the place where the services are rendered determines
the source; and since BOAC's service of transportation is performed outside the Philippines, the
income derived is from sources without the Philippines and, therefore, not taxable under our
income tax laws. The Tax Court upholds that stand in the joint Decision under review.
The absence of flight operations to and from the Philippines is not determinative of the source of
income or the site of income taxation. Admittedly, BOAC was an off-line international airline at
the time pertinent to this case. The test of taxability is the "source"; and the source of an income
is that activity ... which produced the income. 11 Unquestionably, the passage documentations
in these cases were sold in the Philippines and the revenue therefrom was derived from a
activity regularly pursued within the Philippines. business a And even if the BOAC tickets sold
covered the "transport of passengers and cargo to and from foreign cities", 12 it cannot alter the
fact that income from the sale of tickets was derived from the Philippines. The word "source"
conveys one essential idea, that of origin, and the origin of the income herein is the Philippines.
13

It should be pointed out, however, that the assessments upheld herein apply only to the fiscal
years covered by the questioned deficiency income tax assessments in these cases, or, from
1959 to 1967, 1968-69 to 1970-71. For, pursuant to Presidential Decree No. 69, promulgated on
24 November, 1972, international carriers are now taxed as follows:

... Provided, however, That international carriers shall pay a tax of 2-½ per cent
on their cross Philippine billings. (Sec. 24[b] [21, Tax Code).

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

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

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

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

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

SO ORDERED.
G.R. No. 169507

AIR CANADA, Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

DECISION

LEONEN, J.:

An offline international air carrier selling passage tickets in the Philippines, through a general
sales agent, is a resident foreign corporation doing business in the Philippines. As such, it is
taxable under Section 28(A)(l), and not Section 28(A)(3) of the 1997 National Internal Revenue
Code, subject to any applicable tax treaty to which the Philippines is a signatory. Pursuant to
Article 8 of the Republic of the Philippines-Canada Tax Treaty, Air Canada may only be imposed
a maximum tax of 1 ½% of its gross revenues earned from the sale of its tickets in the
Philippines.

This is a Petition for Review1 appealing the August 26, 2005 Decision2 of the Court of Tax
Appeals En Banc, which in turn affirmed the December 22, 2004 Decision3 and April 8, 2005
Resolution4 of the Court of Tax Appeals First Division denying Air Canada’s claim for refund.

Air Canada is a "foreign corporation organized and existing under the laws of Canada[.]"5 On
April 24, 2000, it was granted an authority to operate as an offline carrier by the Civil
Aeronautics Board, subject to certain conditions, which authority would expire on April 24,
2005.6 "As an off-line carrier, [Air Canada] does not have flights originating from or coming to
the Philippines [and does not] operate any airplane [in] the Philippines[.]"7

On July 1, 1999, Air Canada engaged the services of Aerotel Ltd., Corp. (Aerotel) as its general
sales agent in the Philippines.8 Aerotel "sells [Air Canada’s] passage documents in the
Philippines."9

For the period ranging from the third quarter of 2000 to the second quarter of 2002, Air Canada,
through Aerotel, filed quarterly and annual income tax returns and paid the income tax on Gross
Philippine Billings in the total amount of ₱5,185,676.77,10 detailed as follows:

1âwphi1
Applicable Quarter[/]Year Date Filed/Paid Amount of Tax
3rd Qtr 2000 November 29, 2000 P 395,165.00
Annual ITR 2000 April 16, 2001 381,893.59
1st Qtr 2001 May 30, 2001 522,465.39
2nd Qtr 2001 August 29, 2001 1,033,423.34
3rd Qtr 2001 November 29, 2001 765,021.28
Annual ITR 2001 April 15, 2002 328,193.93
 1st Qtr 2002 May 30, 2002 594,850.13
2nd Qtr 2002 August 29, 2002 1,164,664.11
TOTAL P 5,185,676.77 11

On November 28, 2002, Air Canada filed a written claim for refund of alleged erroneously paid
income taxes amounting to ₱5,185,676.77 before the Bureau of Internal Revenue,12 Revenue
District Office No. 47-East Makati.13 It found basis from the revised definition14 of Gross
Philippine Billings under Section 28(A)(3)(a) of the 1997 National Internal Revenue Code:

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

....

(3) International Carrier. - An international carrier doing business in the

Philippines shall pay a tax of two and onehalf percent (2 1/2%) on its ‘Gross
Philippine Billings’ as defined hereunder:

(a) International Air Carrier. - ‘Gross Philippine Billings’ refers to the amount of
gross revenue derived from carriage of persons, excess baggage, cargo
and mail originating from the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of payment of
the ticket or passage document: Provided, That tickets revalidated, exchanged
and/or indorsed to another international airline form part of the Gross Philippine
Billings if the passenger boards a plane in a port or point in the Philippines:
Provided, further, That for a flight which originates from the Philippines, but
transshipment of passenger takes place at any port outside the Philippines on
another airline, only the aliquot portion of the cost of the ticket corresponding to
the leg flown from the Philippines to the point of transshipment shall form part of
Gross Philippine Billings. (Emphasis supplied)

To prevent the running of the prescriptive period, Air Canada filed a Petition for Review before
the Court of Tax Appeals on November 29, 2002.15 The case was docketed as C.T.A. Case No.
6572.16

On December 22, 2004, the Court of Tax Appeals First Division rendered its Decision denying
the Petition for Review and, hence, the claim for refund.17 It found that Air Canada was
engaged in business in the Philippines through a local agent that sells airline tickets on its
behalf. As such, it should be taxed as a resident foreign corporation at the regular rate of
32%.18 Further, according to the Court of Tax Appeals First Division, Air Canada was deemed
to have established a "permanent establishment"19 in the Philippines under Article V(2)(i) of the
Republic of the Philippines-Canada Tax Treaty20 by the appointment of the local sales agent,
"in which [the] petitioner uses its premises as an outlet where sales of [airline] tickets are
made[.]"21

Air Canada seasonably filed a Motion for Reconsideration, but the Motion was denied in the
Court of Tax Appeals First Division’s Resolution dated April 8, 2005 for lack of merit.22 The First
Division held that while Air Canada was not liable for tax on its Gross Philippine Billings under
Section 28(A)(3), it was nevertheless liable to pay the 32% corporate income tax on income
derived from the sale of airline tickets within the Philippines pursuant to Section 28(A)(1).23

On May 9, 2005, Air Canada appealed to the Court of Tax Appeals En Banc.24 The appeal was
docketed as CTA EB No. 86.25

In the Decision dated August 26, 2005, the Court of Tax Appeals En Banc affirmed the findings
of the First Division.26 The En Banc ruled that Air Canada is subject to tax as a resident foreign
corporation doing business in the Philippines since it sold airline tickets in the Philippines.27
The Court of Tax Appeals En Banc disposed thus:

WHEREFORE, premises considered, the instant petition is hereby DENIED DUE COURSE, and
accordingly, DISMISSED for lack of merit.28

Hence, this Petition for Review29 was filed.

The issues for our consideration are:

First, whether petitioner Air Canada, as an offline international carrier selling passage
documents through a general sales agent in the Philippines, is a resident foreign corporation
within the meaning of Section 28(A)(1) of the 1997 National Internal Revenue Code;

Second, whether petitioner Air Canada is subject to the 2½% tax on Gross Philippine Billings
pursuant to Section 28(A)(3). If not, whether an offline international carrier selling passage
documents through a general sales agent can be subject to the regular corporate income tax of
32%30 on taxable income pursuant to Section 28(A)(1);

Third, whether the Republic of the Philippines-Canada Tax Treaty applies, specifically:

a. Whether the Republic of the Philippines-Canada Tax Treaty is enforceable;

b. Whether the appointment of a local general sales agent in the Philippines falls under
the definition of "permanent establishment" under Article V(2)(i) of the Republic of the
Philippines-Canada Tax Treaty; and

Lastly, whether petitioner Air Canada is entitled to the refund of ₱5,185,676.77 pertaining
allegedly to erroneously paid tax on Gross Philippine Billings from the third quarter of 2000 to
the second quarter of 2002.

Petitioner claims that the general provision imposing the regular corporate income tax on
resident foreign corporations provided under Section 28(A)(1) of the 1997 National Internal
Revenue Code does not apply to "international carriers,"31 which are especially classified and
taxed under Section 28(A)(3).32 It adds that the fact that it is no longer subject to Gross
Philippine Billings tax as ruled in the assailed Court of Tax Appeals Decision "does not render it
ipso facto subject to 32% income tax on taxable income as a resident foreign corporation."33
Petitioner argues that to impose the 32% regular corporate income tax on its income would
violate the Philippine government’s covenant under Article VIII of the Republic of the
Philippines-Canada Tax Treaty not to impose a tax higher than 1½% of the carrier’s gross
revenue derived from sources within the Philippines.34 It would also allegedly result in
"inequitable tax treatment of on-line and off-line international air carriers[.]"35

Also, petitioner states that the income it derived from the sale of airline tickets in the Philippines
was income from services and not income from sales of personal property.36 Petitioner cites the
deliberations of the Bicameral Conference Committee on House Bill No. 9077 (which eventually
became the 1997 National Internal Revenue Code), particularly Senator Juan Ponce Enrile’s
statement,37 to reveal the "legislative intent to treat the revenue derived from air carriage as
income from services, and that the carriage of passenger or cargo as the activity that generates
the income."38 Accordingly, applying the principle on the situs of taxation in taxation of services,
petitioner claims that its income derived "from services rendered outside the Philippines [was]
not subject to Philippine income taxation."39

Petitioner further contends that by the appointment of Aerotel as its general sales agent,
petitioner cannot be considered to have a "permanent establishment"40 in the Philippines
pursuant to Article V(6) of the Republic of the Philippines-Canada Tax Treaty.41 It points out that
Aerotel is an "independent general sales agent that acts as such for . . . other international
airline companies in the ordinary course of its business."42 Aerotel sells passage tickets on
behalf of petitioner and receives a commission for its services.43 Petitioner states that even the
Bureau of Internal Revenue—through VAT Ruling No. 003-04 dated February 14, 2004—has
conceded that an offline international air carrier, having no flight operations to and from the
Philippines, is not deemed engaged in business in the Philippines by merely appointing a
general sales agent.44 Finally, petitioner maintains that its "claim for refund of erroneously paid
Gross Philippine Billings cannot be denied on the ground that [it] is subject to income tax under
Section 28 (A) (1)"45 since it has not been assessed at all by the Bureau of Internal Revenue
for any income tax liability.46

On the other hand, respondent maintains that petitioner is subject to the 32% corporate income
tax as a resident foreign corporation doing business in the Philippines. Petitioner’s total payment
of ₱5,185,676.77 allegedly shows that petitioner was earning a sizable income from the sale of
its plane tickets within the Philippines during the relevant period.47 Respondent further points
out that this court in Commissioner of Internal Revenue v. American Airlines, Inc.,48 which in
turn cited the cases involving the British Overseas Airways Corporation and Air India, had
already settled that "foreign airline companies which sold tickets in the Philippines through their
local agents . . . [are] considered resident foreign corporations engaged in trade or business in
the country."49 It also cites Revenue Regulations No. 6-78 dated April 25, 1978, which defined
the phrase "doing business in the Philippines" as including "regular sale of tickets in the
Philippines by offline international airlines either by themselves or through their agents."50

Respondent further contends that petitioner is not entitled to its claim for refund because the
amount of ₱5,185,676.77 it paid as tax from the third quarter of 2000 to the second quarter of
2001 was still short of the 32% income tax due for the period.51 Petitioner cannot allegedly
claim good faith in its failure to pay the right amount of tax since the National Internal Revenue
Code became operative on January 1, 1998 and by 2000, petitioner should have already been
aware of the implications of Section 28(A)(3) and the decided cases of this court’s ruling on the
taxability of offline international carriers selling passage tickets in the Philippines.52

I
At the outset, we affirm the Court of Tax Appeals’ ruling that petitioner, as an offline international
carrier with no landing rights in the Philippines, is not liable to tax on Gross Philippine Billings
under Section 28(A)(3) of the 1997 National Internal Revenue Code:

SEC. 28. Rates of Income Tax on Foreign Corporations. –

(A) Tax on Resident Foreign Corporations. -

....

(3) International Carrier. - An international carrier doing business in the Philippines shall pay a
tax of two and one-half percent (2 1/2%) on its ‘Gross Philippine Billings’ as defined hereunder:

(a) International Air Carrier. - 'Gross Philippine Billings' refers to the amount of
gross revenue derived from carriage of persons, excess baggage, cargo and
mail originating from the Philippines in a continuous and uninterrupted flight,
irrespective of the place of sale or issue and the place of payment of the ticket or
passage document: Provided, That tickets revalidated, exchanged and/or
indorsed to another international airline form part of the Gross Philippine Billings
if the passenger boards a plane in a port or point in the Philippines: Provided,
further, That for a flight which originates from the Philippines, but transshipment
of passenger takes place at any port outside the Philippines on another airline,
only the aliquot portion of the cost of the ticket corresponding to the leg flown
from the Philippines to the point of transshipment shall form part of Gross
Philippine Billings. (Emphasis supplied)

Under the foregoing provision, the tax attaches only when the carriage of persons, excess
baggage, cargo, and mail originated from the Philippines in a continuous and uninterrupted
flight, regardless of where the passage documents were sold.

Not having flights to and from the Philippines, petitioner is clearly not liable for the Gross
Philippine Billings tax.

II

Petitioner, an offline carrier, is a resident foreign corporation for income tax purposes. Petitioner
falls within the definition of resident foreign corporation under Section 28(A)(1) of the 1997
National Internal Revenue Code, thus, it may be subject to 32%53 tax on its taxable income:

SEC. 28. Rates of Income Tax on Foreign Corporations. -

(A) Tax on Resident Foreign Corporations. -

(1) In General. - Except as otherwise provided in this Code, a corporation organized,

authorized, or existing under the laws of any foreign country, engaged in trade or
business within the Philippines, shall be subject to an income tax equivalent to thirty-five
percent (35%) of the taxable income derived in the preceding taxable year from all
sources within 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%54). (Emphasis supplied)

The definition of "resident foreign corporation" has not substantially changed throughout the
amendments of the National Internal Revenue Code. All versions refer to "a foreign corporation
engaged in trade or business within the Philippines."

Commonwealth Act No. 466, known as the National Internal Revenue Code and approved on
June 15, 1939, defined "resident foreign corporation" as applying to "a foreign corporation
engaged in trade or business within the Philippines or having an office or place of business
therein."55

Section 24(b)(2) of the National Internal Revenue Code, as amended by Republic Act No. 6110,
approved on August 4, 1969, reads:

Sec. 24. Rates of tax on corporations. — . . .

(b) Tax on foreign corporations. — . . .

(2) Resident corporations. — A corporation organized, authorized, or existing under the laws of
any foreign country, except a foreign life insurance company, engaged in trade or business
within the Philippines, shall be taxable as provided in subsection (a) of this section upon the
total net income received in the preceding taxable year from all sources within the
Philippines.56 (Emphasis supplied)

Presidential Decree No. 1158-A took effect on June 3, 1977 amending certain sections of the
1939 National Internal Revenue Code. Section 24(b)(2) on foreign resident corporations was
amended, but it still provides that "[a] corporation organized, authorized, or existing under the
laws of any foreign country, engaged in trade or business within the Philippines, shall be taxable
as provided in subsection (a) of this section upon the total net income received in the preceding
taxable year from all sources within the Philippines[.]"57

As early as 1987, this court in Commissioner of Internal Revenue v. British Overseas Airways
Corporation58 declared British Overseas Airways Corporation, an international air carrier with
no landing rights in the Philippines, as a resident foreign corporation engaged in business in the
Philippines through its local sales agent that sold and issued tickets for the airline company.59
This court discussed that:

There is no specific criterion as to what constitutes "doing" or "engaging in" or "transacting"

business. Each case must be judged in the light of its peculiar environmental circumstances.
The term implies a continuity of commercial dealings and arrangements, and contemplates,
to that extent, the performance of acts or works or the exercise of some of the functions
normally incident to, and in progressive prosecution of commercial gain or for the
purpose and object of the business organization. "In order that a foreign corporation may be
regarded as doing business within a State, there must be continuity of conduct and intention to
establish a continuous business, such as the appointment of a local agent, and not one of a
temporary character.["]

BOAC, during the periods covered by the subject-assessments, maintained a general sales
agent in the Philippines. That general sales agent, from 1959 to 1971, "was engaged in (1)
selling and issuing tickets; (2) breaking down the whole trip into series of trips — each trip in the
series corresponding to a different airline company; (3) receiving the fare from the whole trip;
and (4) consequently allocating to the various airline companies on the basis of their
participation in the services rendered through the mode of interline settlement as prescribed by
Article VI of the Resolution No. 850 of the IATA Agreement." Those activities were in exercise of
the functions which are normally incident to, and are in progressive pursuit of, the purpose and
object of its organization as an international air carrier. In fact, the regular sale of tickets, its
main activity, is the very lifeblood of the airline business, the generation of sales being the
paramount objective. There should be no doubt then that BOAC was "engaged in" business in
the Philippines through a local agent during the period covered by the assessments.
Accordingly, it is a resident foreign corporation subject to tax upon its total net income received
in the preceding taxable year from all sources within the Philippines.60 (Emphasis supplied,
citations omitted)

Republic Act No. 7042 or the Foreign Investments Act of 1991 also provides guidance with its
definition of "doing business" with regard to foreign corporations. Section 3(d) of the law
enumerates the activities that constitute doing business:

d. the phrase "doing business" shall include soliciting orders, service contracts, opening
offices, whether called "liaison" offices or branches; appointing representatives or distributors
domiciled in the Philippines or who in any calendar year stay in the country for a period or
periods totalling one hundred eighty (180) days or more; participating in the management,
supervision or control of any domestic business, firm, entity or corporation in the Philippines;
and any other act or acts that imply a continuity of commercial dealings or
arrangements, and contemplate to that extent the performance of acts or works, or the
exercise of some of the functions normally incident to, and in progressive prosecution
of, commercial gain or of the purpose and object of the business organization: Provided,
however, That the phrase "doing business" shall not be deemed to include mere investment as
a shareholder by a foreign entity in domestic corporations duly registered to do business, and/or
the exercise of rights as such investor; nor having a nominee director or officer to represent its
interests in such corporation; nor appointing a representative or distributor domiciled in the
Philippines which transacts business in its own name and for its own account[.]61 (Emphasis
supplied)

While Section 3(d) above states that "appointing a representative or distributor domiciled in the
Philippines which transacts business in its own name and for its own account" is not considered
as "doing business," the Implementing Rules and Regulations of Republic Act No. 7042 clarifies
that "doing business" includes "appointing representatives or distributors, operating under full
control of the foreign corporation, domiciled in the Philippines or who in any calendar year
stay in the country for a period or periods totaling one hundred eighty (180) days or more[.]"62

An offline carrier is "any foreign air carrier not certificated by the [Civil Aeronautics] Board, but
who maintains office or who has designated or appointed agents or employees in the
Philippines, who sells or offers for sale any air transportation in behalf of said foreign air carrier
and/or others, or negotiate for, or holds itself out by solicitation, advertisement, or otherwise
sells, provides, furnishes, contracts, or arranges for such transportation."63

"Anyone desiring to engage in the activities of an off-line carrier [must] apply to the [Civil
Aeronautics] Board for such authority."64 Each offline carrier must file with the Civil Aeronautics
Board a monthly report containing information on the tickets sold, such as the origin and
destination of the passengers, carriers involved, and commissions received.65

Petitioner is undoubtedly "doing business" or "engaged in trade or business" in the Philippines.

Aerotel performs acts or works or exercises functions that are incidental and beneficial to the
purpose of petitioner’s business. The activities of Aerotel bring direct receipts or profits to
petitioner.66 There is nothing on record to show that Aerotel solicited orders alone and for its
own account and without interference from, let alone direction of, petitioner. On the contrary,
Aerotel cannot "enter into any contract on behalf of [petitioner Air Canada] without the express
written consent of [the latter,]"67 and it must perform its functions according to the standards
required by petitioner.68 Through Aerotel, petitioner is able to engage in an economic activity in
the Philippines.

Further, petitioner was issued by the Civil Aeronautics Board an authority to operate as an
offline carrier in the Philippines for a period of five years, or from April 24, 2000 until April 24,
2005.69

Petitioner is, therefore, a resident foreign corporation that is taxable on its income derived from
sources within the Philippines. Petitioner’s income from sale of airline tickets, through Aerotel, is
income realized from the pursuit of its business activities in the Philippines.

III

However, the application of the regular 32% tax rate under Section 28(A)(1) of the 1997
National Internal Revenue Code must consider the existence of an effective tax treaty between
the Philippines and the home country of the foreign air carrier.

In the earlier case of South African Airways v. Commissioner of Internal Revenue,70 this court
held that Section 28(A)(3)(a) does not categorically exempt all international air carriers from the
coverage of Section 28(A)(1). Thus, if Section 28(A)(3)(a) is applicable to a taxpayer, then the
general rule under Section 28(A)(1) does not apply. If, however, Section 28(A)(3)(a) does not
apply, an international air carrier would be liable for the tax under Section 28(A)(1).71

This court in South African Airways declared that the correct interpretation of these provisions is
that: "international air carrier[s] maintain[ing] flights to and from the Philippines . . . shall be
taxed at the rate of 2½% of its Gross Philippine Billings[;] while international air carriers that do
not have flights to and from the Philippines but nonetheless earn income from other activities in
the country [like sale of airline tickets] will be taxed at the rate of 32% of such [taxable]
income."72

In this case, there is a tax treaty that must be taken into consideration to determine the proper
tax rate.

A tax treaty is an agreement entered into between sovereign states "for purposes of eliminating
double taxation on income and capital, preventing fiscal evasion, promoting mutual trade and
investment, and according fair and equitable tax treatment to foreign residents or nationals."73
Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc.74 explained the purpose of a
tax treaty:
The purpose of these international agreements is to reconcile the national fiscal legislations of
the contracting parties in order to help the taxpayer avoid simultaneous taxation in two different
jurisdictions. More precisely, the tax conventions are drafted with a view towards the elimination
of international juridical double taxation, which is defined as the imposition of comparable taxes
in two or more states on the same taxpayer in respect of the same subject matter and for
identical periods.

The apparent rationale for doing away with double taxation is to encourage the free flow of
goods and services and the movement of capital, technology and persons between countries,
conditions deemed vital in creating robust and dynamic economies. Foreign investments will
only thrive in a fairly predictable and reasonable international investment climate and the
protection against double taxation is crucial in creating such a climate.75 (Emphasis in the
original, citations omitted)

Observance of any treaty obligation binding upon the government of the Philippines is anchored
on the constitutional provision that the Philippines "adopts the generally accepted principles of
international law as part of the law of the land[.]"76 Pacta sunt servanda is a fundamental
international law principle that requires agreeing parties to comply with their treaty obligations in
good faith.77

Hence, the application of the provisions of the National Internal Revenue Code must be subject
to the provisions of tax treaties entered into by the Philippines with foreign countries.

In Deutsche Bank AG Manila Branch v. Commissioner of Internal Revenue,78 this court

stressed the binding effects of tax treaties. It dealt with the issue of "whether the failure to strictly
comply with [Revenue Memorandum Order] RMO No. 1-200079 will deprive persons or
corporations of the benefit of a tax treaty."80 Upholding the tax treaty over the administrative
issuance, this court reasoned thus:

Our Constitution provides for adherence to the general principles of international law as part of
the law of the land. The time-honored international principle of pacta sunt servanda demands
the performance in good faith of treaty obligations on the part of the states that enter into the
agreement. Every treaty in force is binding upon the parties, and obligations under the treaty
must be performed by them in good faith. More importantly, treaties have the force and effect
of law in this jurisdiction.

Tax treaties are entered into "to reconcile the national fiscal legislations of the contracting
parties and, in turn, help the taxpayer avoid simultaneous taxations in two different jurisdictions."
CIR v. S.C. Johnson and Son, Inc. further clarifies that "tax conventions are drafted with a view
towards the elimination of international juridical double taxation, which is defined as the
imposition of comparable taxes in two or more states on the same taxpayer in respect of the
same subject matter and for identical periods. The apparent rationale for doing away with
double taxation is to encourage the free flow of goods and services and the movement of
capital, technology and persons between countries, conditions deemed vital in creating robust
and dynamic economies. Foreign investments will only thrive in a fairly predictable and
reasonable international investment climate and the protection against double taxation is crucial
in creating such a climate." Simply put, tax treaties are entered into to minimize, if not eliminate
the harshness of international juridical double taxation, which is why they are also known as
double tax treaty or double tax agreements.
"A state that has contracted valid international obligations is bound to make in its legislations
those modifications that may be necessary to ensure the fulfillment of the obligations
undertaken." Thus, laws and issuances must ensure that the reliefs granted under tax treaties
are accorded to the parties entitled thereto. The BIR must not impose additional requirements
that would negate the availment of the reliefs provided for under international agreements. More
so, when the RPGermany Tax Treaty does not provide for any pre-requisite for the availment of
the benefits under said agreement.

....

Bearing in mind the rationale of tax treaties, the period of application for the availment of tax
treaty relief as required by RMO No. 1-2000 should not operate to divest entitlement to the relief
as it would constitute a violation of the duty required by good faith in complying with a tax treaty.
The denial of the availment of tax relief for the failure of a taxpayer to apply within the
prescribed period under the administrative issuance would impair the value of the tax treaty. At
most, the application for a tax treaty relief from the BIR should merely operate to confirm the
entitlement of the taxpayer to the relief.

The obligation to comply with a tax treaty must take precedence over the objective of RMO No.
1-2000. Logically, noncompliance with tax treaties has negative implications on international
relations, and unduly discourages foreign investors. While the consequences sought to be
prevented by RMO No. 1-2000 involve an administrative procedure, these may be remedied
through other system management processes, e.g., the imposition of a fine or penalty. But we
cannot totally deprive those who are entitled to the benefit of a treaty for failure to strictly comply
with an administrative issuance requiring prior application for tax treaty relief.81 (Emphasis
supplied, citations omitted)

On March 11, 1976, the representatives82 for the government of the Republic of the Philippines
and for the government of Canada signed the Convention between the Philippines and Canada
for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income (Republic of the Philippines-Canada Tax Treaty). This treaty entered into force
on December 21, 1977.

Article V83 of the Republic of the Philippines-Canada Tax Treaty defines "permanent
establishment" as a "fixed place of business in which the business of the enterprise is wholly or
partly carried on."84

Even though there is no fixed place of business, an enterprise of a Contracting State is deemed
to have a permanent establishment in the other Contracting State if under certain conditions
there is a person acting for it.

Specifically, Article V(4) of the Republic of the Philippines-Canada Tax Treaty states that "[a]
person acting in a Contracting State on behalf of an enterprise of the other Contracting State
(other than an agent of independent status to whom paragraph 6 applies) shall be deemed to be
a permanent establishment in the first-mentioned State if . . . he has and habitually exercises in
that State an authority to conclude contracts on behalf of the enterprise, unless his activities are
limited to the purchase of goods or merchandise for that enterprise[.]" The provision seems to
refer to one who would be considered an agent under Article 186885 of the Civil Code of the
Philippines.
On the other hand, Article V(6) provides that "[a]n enterprise of a Contracting State shall not be
deemed to have a permanent establishment in the other Contracting State merely because it
carries on business in that other State through a broker, general commission agent or any
other agent of an independent status, where such persons are acting in the ordinary course
of their business."

Considering Article XV86 of the same Treaty, which covers dependent personal services, the
term "dependent" would imply a relationship between the principal and the agent that is akin to
an employer-employee relationship.

Thus, an agent may be considered to be dependent on the principal where the latter exercises
comprehensive control and detailed instructions over the means and results of the activities of
the agent.87

Section 3 of Republic Act No. 776, as amended, also known as The Civil Aeronautics Act of the
Philippines, defines a general sales agent as "a person, not a bonafide employee of an air
carrier, who pursuant to an authority from an airline, by itself or through an agent, sells or offers
for sale any air transportation, or negotiates for, or holds himself out by solicitation,
advertisement or otherwise as one who sells, provides, furnishes, contracts or arranges for,
such air transportation."88 General sales agents and their property, property rights, equipment,
facilities, and franchise are subject to the regulation and control of the Civil Aeronautics
Board.89 A permit or authorization issued by the Civil Aeronautics Board is required before a
general sales agent may engage in such an activity.90

Through the appointment of Aerotel as its local sales agent, petitioner is deemed to have
created a "permanent establishment" in the Philippines as defined under the Republic of the
Philippines-Canada Tax Treaty.

Petitioner appointed Aerotel as its passenger general sales agent to perform the sale of
transportation on petitioner and handle reservations, appointment, and supervision of
International Air Transport Associationapproved and petitioner-approved sales agents, including
the following services:

ARTICLE 7
GSA SERVICES

The GSA [Aerotel Ltd., Corp.] shall perform on behalf of AC [Air Canada] the following services:

a) Be the fiduciary of AC and in such capacity act solely and entirely for the benefit of AC in
every matter relating to this Agreement;

....

c) Promotion of passenger transportation on AC;

....
e) Without the need for endorsement by AC, arrange for the reissuance, in the Territory of the
GSA [Philippines], of traffic documents issued by AC outside the said territory of the GSA
[Philippines], as required by the passenger(s);

....

h) Distribution among passenger sales agents and display of timetables, fare sheets, tariffs and
publicity material provided by AC in accordance with the reasonable requirements of AC;

....

j) Distribution of official press releases provided by AC to media and reference of any press or
public relations inquiries to AC;

....

o) Submission for AC’s approval, of an annual written sales plan on or before a date to be
determined by AC and in a form acceptable to AC;

....

q) Submission of proposals for AC’s approval of passenger sales agent incentive plans at a
reasonable time in advance of proposed implementation.

r) Provision of assistance on request, in its relations with Governmental and other authorities,
offices and agencies in the Territory [Philippines].

....

u) Follow AC guidelines for the handling of baggage claims and customer complaints and,
unless otherwise stated in the guidelines, refer all such claims and complaints to AC.91

Under the terms of the Passenger General Sales Agency Agreement, Aerotel will "provide at its
own expense and acceptable to [petitioner Air Canada], adequate and suitable premises,
qualified staff, equipment, documentation, facilities and supervision and in consideration of the
remuneration and expenses payable[,] [will] defray all costs and expenses of and incidental to
the Agency."92 "[I]t is the sole employer of its employees and . . . is responsible for [their]
actions . . . or those of any subcontractor."93 In remuneration for its services, Aerotel would be
paid by petitioner a commission on sales of transportation plus override commission on flown
revenues.94 Aerotel would also be reimbursed "for all authorized expenses supported by
original supplier invoices."95

Aerotel is required to keep "separate books and records of account, including supporting
documents, regarding all transactions at, through or in any way connected with [petitioner Air
Canada] business."96

"If representing more than one carrier, [Aerotel must] represent all carriers in an unbiased
way."97 Aerotel cannot "accept additional appointments as General Sales Agent of any other
carrier without the prior written consent of [petitioner Air Canada]."98
The Passenger General Sales Agency Agreement "may be terminated by either party without
cause upon [no] less than 60 days’ prior notice in writing[.]"99 In case of breach of any
provisions of the Agreement, petitioner may require Aerotel "to cure the breach in 30 days failing
which [petitioner Air Canada] may terminate [the] Agreement[.]"100

The following terms are indicative of Aerotel’s dependent status:

First, Aerotel must give petitioner written notice "within 7 days of the date [it] acquires or takes
control of another entity or merges with or is acquired or controlled by another person or
entity[.]"101 Except with the written consent of petitioner, Aerotel must not acquire a substantial
interest in the ownership, management, or profits of a passenger sales agent affiliated with the
International Air Transport Association or a non-affiliated passenger sales agent nor shall an
affiliated passenger sales agent acquire a substantial interest in Aerotel as to influence its
commercial policy and/or management decisions.102 Aerotel must also provide petitioner "with
a report on any interests held by [it], its owners, directors, officers, employees and their
immediate families in companies and other entities in the aviation industry or . . . industries
related to it[.]"103 Petitioner may require that any interest be divested within a set period of
time.104

Second, in carrying out the services, Aerotel cannot enter into any contract on behalf of
petitioner without the express written consent of the latter;105 it must act according to the
standards required by petitioner;106 "follow the terms and provisions of the [petitioner Air
Canada] GSA Manual [and all] written instructions of [petitioner Air Canada;]"107 and "[i]n the
absence of an applicable provision in the Manual or instructions, [Aerotel must] carry out its
functions in accordance with [its own] standard practices and procedures[.]"108

Third, Aerotel must only "issue traffic documents approved by [petitioner Air Canada] for all
transportation over [its] services[.]"109 All use of petitioner’s name, logo, and marks must be
with the written consent of petitioner and according to petitioner’s corporate standards and
guidelines set out in the Manual.110

Fourth, all claims, liabilities, fines, and expenses arising from or in connection with the
transportation sold by Aerotel are for the account of petitioner, except in the case of negligence
of Aerotel.111

Aerotel is a dependent agent of petitioner pursuant to the terms of the Passenger General Sales
Agency Agreement executed between the parties. It has the authority or power to conclude
contracts or bind petitioner to contracts entered into in the Philippines. A third-party liability on
contracts of Aerotel is to petitioner as the principal, and not to Aerotel, and liability to such third
party is enforceable against petitioner. While Aerotel maintains a certain independence and its
activities may not be devoted wholly to petitioner, nonetheless, when representing petitioner
pursuant to the Agreement, it must carry out its functions solely for the benefit of petitioner and
according to the latter’s Manual and written instructions. Aerotel is required to submit its annual
sales plan for petitioner’s approval.

In essence, Aerotel extends to the Philippines the transportation business of petitioner. It is a

conduit or outlet through which petitioner’s airline tickets are sold.112

Under Article VII (Business Profits) of the Republic of the Philippines-Canada Tax Treaty, the
"business profits" of an enterprise of a Contracting State is "taxable only in that State[,] unless
the enterprise carries on business in the other Contracting State through a permanent
establishment[.]"113 Thus, income attributable to Aerotel or from business activities effected by
petitioner through Aerotel may be taxed in the Philippines. However, pursuant to the last
paragraph114 of Article VII in relation to Article VIII115 (Shipping and Air Transport) of the same
Treaty, the tax imposed on income derived from the operation of ships or aircraft in international
traffic should not exceed 1½% of gross revenues derived from Philippine sources.

IV

While petitioner is taxable as a resident foreign corporation under Section 28(A)(1) of the 1997
National Internal Revenue Code on its taxable income116 from sale of airline tickets in the
Philippines, it could only be taxed at a maximum of 1½% of gross revenues, pursuant to Article
VIII of the Republic of the Philippines-Canada Tax Treaty that applies to petitioner as a "foreign
corporation organized and existing under the laws of Canada[.]"117

Tax treaties form part of the law of the land,118 and jurisprudence has applied the statutory
construction principle that specific laws prevail over general ones.119

The Republic of the Philippines-Canada Tax Treaty was ratified on December 21, 1977 and
became valid and effective on that date. On the other hand, the applicable provisions120
relating to the taxability of resident foreign corporations and the rate of such tax found in the
National Internal Revenue Code became effective on January 1, 1998.121 Ordinarily, the later
provision governs over the earlier one.122 In this case, however, the provisions of the Republic
of the Philippines-Canada Tax Treaty are more specific than the provisions found in the National
Internal Revenue Code.

These rules of interpretation apply even though one of the sources is a treaty and not simply a
statute.

Article VII, Section 21 of the Constitution provides:

SECTION 21. No treaty or international agreement shall be valid and effective unless concurred
in by at least two-thirds of all the Members of the Senate.

This provision states the second of two ways through which international obligations become
binding. Article II, Section 2 of the Constitution deals with international obligations that are
incorporated, while Article VII, Section 21 deals with international obligations that become
binding through ratification.

"Valid and effective" means that treaty provisions that define rights and duties as well as definite
prestations have effects equivalent to a statute. Thus, these specific treaty provisions may
amend statutory provisions. Statutory provisions may also amend these types of treaty
obligations.

We only deal here with bilateral treaty state obligations that are not international obligations
erga omnes. We are also not required to rule in this case on the effect of international
customary norms especially those with jus cogens character.

The second paragraph of Article VIII states that "profits from sources within a Contracting State
derived by an enterprise of the other Contracting State from the operation of ships or aircraft in
international traffic may be taxed in the first-mentioned State but the tax so charged shall not
exceed the lesser of a) one and one-half per cent of the gross revenues derived from sources in
that State; and b) the lowest rate of Philippine tax imposed on such profits derived by an
enterprise of a third State."

The Agreement between the government of the Republic of the Philippines and the government
of Canada on Air Transport, entered into on January 14, 1997, reiterates the effectivity of Article
VIII of the Republic of the Philippines-Canada Tax Treaty:

ARTICLE XVI
(Taxation)

The Contracting Parties shall act in accordance with the provisions of Article VIII of the
Convention between the Philippines and Canada for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income, signed at Manila on March 31,
1976 and entered into force on December 21, 1977, and any amendments thereto, in respect of
the operation of aircraft in international traffic.123

Petitioner’s income from sale of ticket for international carriage of passenger is income derived
from international operation of aircraft. The sale of tickets is closely related to the international
operation of aircraft that it is considered incidental thereto.

"[B]y reason of our bilateral negotiations with [Canada], we have agreed to have our right to tax
limited to a certain extent[.]"124 Thus, we are bound to extend to a Canadian air carrier doing
business in the Philippines through a local sales agent the benefit of a lower tax equivalent to
1½% on business profits derived from sale of international air transportation.

Finally, we reject petitioner’s contention that the Court of Tax Appeals erred in denying its claim
for refund of erroneously paid Gross Philippine Billings tax on the ground that it is subject to
income tax under Section 28(A)(1) of the National Internal Revenue Code because (a) it has not
been assessed at all by the Bureau of Internal Revenue for any income tax liability;125 and (b)
internal revenue taxes cannot be the subject of set-off or compensation,126 citing Republic v.
Mambulao Lumber Co., et al.127 and Francia v. Intermediate Appellate Court.128

In SMI-ED Philippines Technology, Inc. v. Commissioner of Internal Revenue,129 we have ruled

that "[i]n an action for the refund of taxes allegedly erroneously paid, the Court of Tax Appeals
may determine whether there are taxes that should have been paid in lieu of the taxes paid."130
The determination of the proper category of tax that should have been paid is incidental and
necessary to resolve the issue of whether a refund should be granted.131 Thus:

Petitioner argued that the Court of Tax Appeals had no jurisdiction to subject it to 6% capital
gains tax or other taxes at the first instance. The Court of Tax Appeals has no power to make an
assessment.

As earlier established, the Court of Tax Appeals has no assessment powers. In stating that
petitioner’s transactions are subject to capital gains tax, however, the Court of Tax Appeals was
not making an assessment. It was merely determining the proper category of tax that petitioner
should have paid, in view of its claim that it erroneously imposed upon itself and paid the 5%
final tax imposed upon PEZA-registered enterprises.

The determination of the proper category of tax that petitioner should have paid is an incidental
matter necessary for the resolution of the principal issue, which is whether petitioner was
entitled to a refund.

The issue of petitioner’s claim for tax refund is intertwined with the issue of the proper taxes that
are due from petitioner. A claim for tax refund carries the assumption that the tax returns filed
were correct. If the tax return filed was not proper, the correctness of the amount paid and,
therefore, the claim for refund become questionable. In that case, the court must determine if a
taxpayer claiming refund of erroneously paid taxes is more properly liable for taxes other than
that paid.

In South African Airways v. Commissioner of Internal Revenue, South African Airways claimed
for refund of its erroneously paid 2½% taxes on its gross Philippine billings. This court did not
immediately grant South African’s claim for refund. This is because although this court found
that South African Airways was not subject to the 2½% tax on its gross Philippine billings, this
court also found that it was subject to 32% tax on its taxable income.

In this case, petitioner’s claim that it erroneously paid the 5% final tax is an admission that the
quarterly tax return it filed in 2000 was improper. Hence, to determine if petitioner was entitled to
the refund being claimed, the Court of Tax Appeals has the duty to determine if petitioner was
indeed not liable for the 5% final tax and, instead, liable for taxes other than the 5% final tax. As
in South African Airways, petitioner’s request for refund can neither be granted nor denied
outright without such determination.

If the taxpayer is found liable for taxes other than the erroneously paid 5% final tax, the amount
of the taxpayer’s liability should be computed and deducted from the refundable amount.

Any liability in excess of the refundable amount, however, may not be collected in a case
involving solely the issue of the taxpayer’s entitlement to refund. The question of tax deficiency
is distinct and unrelated to the question of petitioner’s entitlement to refund. Tax deficiencies
should be subject to assessment procedures and the rules of prescription. The court cannot be
expected to perform the BIR’s duties whenever it fails to do so either through neglect or
oversight. Neither can court processes be used as a tool to circumvent laws protecting the rights
of taxpayers.132

Hence, the Court of Tax Appeals properly denied petitioner’s claim for refund of allegedly
erroneously paid tax on its Gross Philippine Billings, on the ground that it was liable instead for
the regular 32% tax on its taxable income received from sources within the Philippines. Its
determination of petitioner’s liability for the 32% regular income tax was made merely for the
purpose of ascertaining petitioner’s entitlement to a tax refund and not for imposing any
deficiency tax.

In this regard, the matter of set-off raised by petitioner is not an issue. Besides, the cases cited
are based on different circumstances. In both cited cases,133 the taxpayer claimed that his (its)
tax liability was off-set by his (its) claim against the government.
Specifically, in Republic v. Mambulao Lumber Co., et al., Mambulao Lumber contended that the
amounts it paid to the government as reforestation charges from 1947 to 1956, not having been
used in the reforestation of the area covered by its license, may be set off or applied to the
payment of forest charges still due and owing from it.134 Rejecting Mambulao’s claim of legal
compensation, this court ruled:

[A]ppellant and appellee are not mutually creditors and debtors of each other. Consequently, the
law on compensation is inapplicable. On this point, the trial court correctly observed:

Under Article 1278, NCC, compensation should take place when two persons in their own right
are creditors and debtors of each other. With respect to the forest charges which the defendant
Mambulao Lumber Company has paid to the government, they are in the coffers of the
government as taxes collected, and the government does not owe anything to defendant
Mambulao Lumber Company. So, it is crystal clear that the Republic of the Philippines and the
Mambulao Lumber Company are not creditors and debtors of each other, because
compensation refers to mutual debts. * * *.

And the weight of authority is to the effect that internal revenue taxes, such as the forest
charges in question, can not be the subject of set-off or compensation.

A claim for taxes is not such a debt, demand, contract or judgment as is allowed to be set-off
under the statutes of set-off, which are construed uniformly, in the light of public policy, to
exclude the remedy in an action or any indebtedness of the state or municipality to one who is
liable to the state or municipality for taxes. Neither are they a proper subject of recoupment
since they do not arise out of the contract or transaction sued on. * * *. (80 C.J.S. 73–74.)

The general rule, based on grounds of public policy is well-settled that no set-off is admissible
against demands for taxes levied for general or local governmental purposes. The reason on
which the general rule is based, is that taxes are not in the nature of contracts between the
party and party but grow out of a duty to, and are the positive acts of the government, to the
making and enforcing of which, the personal consent of individual taxpayers is not required. * * *
If the taxpayer can properly refuse to pay his tax when called upon by the Collector, because he
has a claim against the governmental body which is not included in the tax levy, it is plain that
some legitimate and necessary expenditure must be curtailed. If the taxpayer’s claim is
disputed, the collection of the tax must await and abide the result of a lawsuit, and meanwhile
the financial affairs of the government will be thrown into great confusion. (47 Am. Jur. 766–
767.)135 (Emphasis supplied)

In Francia, this court did not allow legal compensation since not all requisites of legal
compensation provided under Article 1279 were present.136 In that case, a portion of Francia’s
property in Pasay was expropriated by the national government,137 which did not immediately
pay Francia. In the meantime, he failed to pay the real property tax due on his remaining
property to the local government of Pasay, which later on would auction the property on account
of such delinquency.138 He then moved to set aside the auction sale and argued, among
others, that his real property tax delinquency was extinguished by legal compensation on
account of his unpaid claim against the national government.139 This court ruled against
Francia:

There is no legal basis for the contention. By legal compensation, obligations of persons, who in
their own right are reciprocally debtors and creditors of each other, are extinguished (Art. 1278,
Civil Code). The circumstances of the case do not satisfy the requirements provided by Article
1279, to wit:

(1) that each one of the obligors be bound principally and that he be at the same time a
principal creditor of the other;

xxx xxx xxx

(3) that the two debts be due.

xxx xxx xxx

This principal contention of the petitioner has no merit. We have consistently ruled that there
can be no off-setting of taxes against the claims that the taxpayer may have against the
government. A person cannot refuse to pay a tax on the ground that the government owes him
an amount equal to or greater than the tax being collected. The collection of a tax cannot await
the results of a lawsuit against the government.

....

There are other factors which compel us to rule against the petitioner. The tax was due to the
city government while the expropriation was effected by the national government. Moreover, the
amount of ₱4,116.00 paid by the national government for the 125 square meter portion of his lot
was deposited with the Philippine National Bank long before the sale at public auction of his
remaining property. Notice of the deposit dated September 28, 1977 was received by the
petitioner on September 30, 1977. The petitioner admitted in his testimony that he knew about
the ₱4,116.00 deposited with the bank but he did not withdraw it. It would have been an easy
matter to withdraw ₱2,400.00 from the deposit so that he could pay the tax obligation thus
aborting the sale at public auction.140

The ruling in Francia was applied to the subsequent cases of Caltex Philippines, Inc. v.
Commission on Audit141 and Philex Mining Corporation v. Commissioner of Internal
Revenue.142 In Caltex, this court reiterated:

[A] taxpayer may not offset taxes due from the claims that he may have against the government.
Taxes cannot be the subject of compensation because the government and taxpayer are not
mutually creditors and debtors of each other and a claim for taxes is not such a debt, demand,
contract or judgment as is allowed to be set-off.143 (Citations omitted)

Philex Mining ruled that "[t]here is a material distinction between a tax and debt. Debts are due
to the Government in its corporate capacity, while taxes are due to the Government in its
sovereign capacity."144 Rejecting Philex Mining’s assertion that the imposition of surcharge and
interest was unjustified because it had no obligation to pay the excise tax liabilities within the
prescribed period since, after all, it still had pending claims for VAT input credit/refund with the
Bureau of Internal Revenue, this court explained:

To be sure, we cannot allow Philex to refuse the payment of its tax liabilities on the ground that it
has a pending tax claim for refund or credit against the government which has not yet been
granted. It must be noted that a distinguishing feature of a tax is that it is compulsory rather than
a matter of bargain. Hence, a tax does not depend upon the consent of the taxpayer. If any tax
payer can defer the payment of taxes by raising the defense that it still has a pending claim for
refund or credit, this would adversely affect the government revenue system. A taxpayer cannot
refuse to pay his taxes when they fall due simply because he has a claim against the
government or that the collection of the tax is contingent on the result of the lawsuit it filed
against the government. Moreover, Philex’s theory that would automatically apply its VAT input
credit/refund against its tax liabilities can easily give rise to confusion and abuse, depriving the
government of authority over the manner by which taxpayers credit and offset their tax
liabilities.145 (Citations omitted)

In sum, the rulings in those cases were to the effect that the taxpayer cannot simply refuse to
pay tax on the ground that the tax liabilities were off-set against any alleged claim the taxpayer
may have against the government. Such would merely be in keeping with the basic policy on
prompt collection of taxes as the lifeblood of the government.1âwphi1

Here, what is involved is a denial of a taxpayer’s refund claim on account of the Court of Tax
Appeals’ finding of its liability for another tax in lieu of the Gross Philippine Billings tax that was
allegedly erroneously paid.

Squarely applicable is South African Airways where this court rejected similar arguments on the
denial of claim for tax refund:

Commissioner of Internal Revenue v. Court of Tax Appeals, however, granted the offsetting of a
tax refund with a tax deficiency in this wise:

Further, it is also worth noting that the Court of Tax Appeals erred in denying petitioner’s
supplemental motion for reconsideration alleging bringing to said court’s attention the existence
of the deficiency income and business tax assessment against Citytrust. The fact of such
deficiency assessment is intimately related to and inextricably intertwined with the right of
respondent bank to claim for a tax refund for the same year. To award such refund despite the
existence of that deficiency assessment is an absurdity and a polarity in conceptual effects.
Herein private respondent cannot be entitled to refund and at the same time be liable for a tax
deficiency assessment for the same year.

The grant of a refund is founded on the assumption that the tax return is valid, that is, the facts
stated therein are true and correct. The deficiency assessment, although not yet final, created a
doubt as to and constitutes a challenge against the truth and accuracy of the facts stated in said
return which, by itself and without unquestionable evidence, cannot be the basis for the grant of
the refund.

Section 82, Chapter IX of the National Internal Revenue Code of 1977, which was the
applicable law when the claim of Citytrust was filed, provides that "(w)hen an assessment is
made in case of any list, statement, or return, which in the opinion of the Commissioner of
Internal Revenue was false or fraudulent or contained any understatement or undervaluation, no
tax collected under such assessment shall be recovered by any suits unless it is proved that the
said list, statement, or return was not false nor fraudulent and did not contain any
understatement or undervaluation; but this provision shall not apply to statements or returns
made or to be made in good faith regarding annual depreciation of oil or gas wells and mines."

Moreover, to grant the refund without determination of the proper assessment and the tax due
would inevitably result in multiplicity of proceedings or suits. If the deficiency assessment should
subsequently be upheld, the Government will be forced to institute anew a proceeding for the
recovery of erroneously refunded taxes which recourse must be filed within the prescriptive
period of ten years after discovery of the falsity, fraud or omission in the false or fraudulent
return involved. This would necessarily require and entail additional efforts and expenses on the
part of the Government, impose a burden on and a drain of government funds, and impede or
delay the collection of much-needed revenue for governmental operations.

Thus, to avoid multiplicity of suits and unnecessary difficulties or expenses, it is both logically
necessary and legally appropriate that the issue of the deficiency tax assessment against
Citytrust be resolved jointly with its claim for tax refund, to determine once and for all in a single
proceeding the true and correct amount of tax due or refundable.

In fact, as the Court of Tax Appeals itself has heretofore conceded, it would be only just and fair
that the taxpayer and the Government alike be given equal opportunities to avail of remedies
under the law to defeat each other’s claim and to determine all matters of dispute between them
in one single case. It is important to note that in determining whether or not petitioner is entitled
to the refund of the amount paid, it would [be] necessary to determine how much the
Government is entitled to collect as taxes. This would necessarily include the determination of
the correct liability of the taxpayer and, certainly, a determination of this case would constitute
res judicata on both parties as to all the matters subject thereof or necessarily involved therein.

Sec. 82, Chapter IX of the 1977 Tax Code is now Sec. 72, Chapter XI of the 1997 NIRC. The
above pronouncements are, therefore, still applicable today.

Here, petitioner's similar tax refund claim assumes that the tax return that it filed was correct.
Given, however, the finding of the CTA that petitioner, although not liable under Sec. 28(A)(3)(a)
of the 1997 NIRC, is liable under Sec. 28(A)(l), the correctness of the return filed by petitioner is
now put in doubt. As such, we cannot grant the prayer for a refund.146 (Emphasis supplied,
citation omitted)

In the subsequent case of United Airlines, Inc. v. Commissioner of Internal Revenue, 147 this
court upheld the denial of the claim for refund based on the Court of Tax Appeals' finding that
the taxpayer had, through erroneous deductions on its gross income, underpaid its Gross
Philippine Billing tax on cargo revenues for 1999, and the amount of underpayment was even
greater than the refund sought for erroneously paid Gross Philippine Billings tax on passenger
revenues for the same taxable period.148

In this case, the P5,185,676.77 Gross Philippine Billings tax paid by petitioner was computed at
the rate of 1 ½% of its gross revenues amounting to P345,711,806.08149 from the third quarter
of 2000 to the second quarter of 2002. It is quite apparent that the tax imposable under Section
28(A)(l) of the 1997 National Internal Revenue Code [32% of t.axable income, that is, gross
income less deductions] will exceed the maximum ceiling of 1 ½% of gross revenues as
decreed in Article VIII of the Republic of the Philippines-Canada Tax Treaty. Hence, no refund is
forthcoming.

WHEREFORE, the Petition is DENIED. The Decision dated August 26, 2005 and Resolution
dated April 8, 2005 of the Court of Tax Appeals En Banc are AFFIRMED.

SO ORDERED.
G.R. No. 160756 March 9, 2010

CHAMBER OF REAL ESTATE AND BUILDERS' ASSOCIATIONS, INC., Petitioner,

vs.
THE HON. EXECUTIVE SECRETARY ALBERTO ROMULO, THE HON. ACTING SECRETARY
OF FINANCE JUANITA D. AMATONG, and THE HON. COMMISSIONER OF INTERNAL
REVENUE GUILLERMO PARAYNO, JR., Respondents.

DECISION

CORONA, J.:

In this original petition for certiorari and mandamus,1 petitioner Chamber of Real Estate and
Builders’ Associations, Inc. is questioning the constitutionality of Section 27 (E) of Republic Act
(RA) 84242 and the revenue regulations (RRs) issued by the Bureau of Internal Revenue (BIR)
to implement said provision and those involving creditable withholding taxes.3

Petitioner is an association of real estate developers and builders in the Philippines. It

impleaded former Executive Secretary Alberto Romulo, then acting Secretary of Finance Juanita
D. Amatong and then Commissioner of Internal Revenue Guillermo Parayno, Jr. as
respondents.

Petitioner assails the validity of the imposition of minimum corporate income tax (MCIT) on
corporations and creditable withholding tax (CWT) on sales of real properties classified as
ordinary assets.

Section 27(E) of RA 8424 provides for MCIT on domestic corporations and is implemented by
RR 9-98. Petitioner argues that the MCIT violates the due process clause because it levies
income tax even if there is no realized gain.

Petitioner also seeks to nullify Sections 2.57.2(J) (as amended by RR 6-2001) and 2.58.2 of RR
2-98, and Section 4(a)(ii) and (c)(ii) of RR 7-2003, all of which prescribe the rules and
procedures for the collection of CWT on the sale of real properties categorized as ordinary
assets. Petitioner contends that these revenue regulations are contrary to law for two reasons:
first, they ignore the different treatment by RA 8424 of ordinary assets and capital assets and
second, respondent Secretary of Finance has no authority to collect CWT, much less, to base
the CWT on the gross selling price or fair market value of the real properties classified as
ordinary assets.

Petitioner also asserts that the enumerated provisions of the subject revenue regulations 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;
 (2) whether or not the imposition of the MCIT on domestic corporations is
unconstitutional and

(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 7-2003, 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 –

Exempt
Those which are exempt from a
withholding tax at source as
prescribed in Sec. 2.57.5 of these
regulations.

1.5%
With a selling price of five hundred
thousand pesos (₱500,000.00) or
less.

3.0%
With a selling price of more than
five hundred thousand pesos
(₱500,000.00) but not more than
two million pesos (₱2,000,000.00).

5.0%
With selling price of more than two
million pesos (₱2,000,000.00)

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:

Exempt
Where the seller/transferor is exempt from [CWT] in
accordance with Sec. 2.57.5 of these regulations.

Upon the following values of real property, where the

seller/transferor is habitually engaged in the real estate
business.

1.5%
With a selling price of Five Hundred Thousand Pesos
(₱500,000.00) or less.

3.0%
With a selling price of more than Five Hundred Thousand
Pesos (₱500,000.00) but not more than Two Million
Pesos (₱2,000,000.00).

5.0%
With a selling price of more than two Million Pesos
(₱2,000,000.00).

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. 7-20038 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 petitioner’s 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 party’s 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%), there’s 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 you’ll 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 corporation’s 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 measure39 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 goods48 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 corporation’s 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 AMT’s 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 law’s unconstitutionality has the burden to
demonstrate the supposed violations in understandable terms.60

RR 9-98 Merely Clarifies Section 27(E) of RA 8424

Petitioner alleges that RR 9-98 is a deprivation of property without due process of law because
the MCIT is being imposed and collected even when there is actually a loss, or a zero or
negative taxable income:

Sec. 2.27(E) [MCIT] on Domestic Corporations. —

(1) Imposition of the Tax. — xxx 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. (Emphasis supplied)

RR 9-98, in declaring that MCIT should be imposed whenever such corporation has zero or
negative taxable income, merely defines the coverage of Section 27(E). This 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 notwithstanding the amount of the net income.
But the law also states that the MCIT is to be paid only if it is greater than the normal net
income. Obviously, it may well be the case that the MCIT would be less than the net income of
the corporation which posts a zero or negative taxable income.

We now proceed to the issues involving the CWT.

The withholding tax system is a procedure through which taxes (including income taxes) are
collected.61 Under Section 57 of RA 8424, the types of income subject to withholding tax are
divided into three categories: (a) withholding of final tax on certain incomes; (b) withholding of
creditable tax at source and (c) tax-free covenant bonds. Petitioner is concerned with the
second category (CWT) and maintains that the revenue regulations on the collection of CWT on
sale of real estate categorized as ordinary assets are unconstitutional.

Petitioner, after enumerating the distinctions between capital and ordinary assets under RA
8424, contends that Sections 2.57.2(J) and 2.58.2 of RR 2-98 and Sections 4(a)(ii) and (c)(ii) of
RR 7-2003 were promulgated "with grave abuse of discretion amounting to lack of jurisdiction"
and "patently in contravention of law"62 because they ignore such distinctions. Petitioner’s
conclusion is based on the 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 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 to RA 8424 which calls for the payment of the net income at the end of the taxable
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 regards the tax base,
modes of collection and payment of taxes on income from the sale of capital and ordinary
assets.

Petitioner’s arguments have no merit.

Authority of the Secretary of Finance to Order the Collection of CWT on Sales of Real
Property Considered as Ordinary Assets

The Secretary of Finance is granted, under Section 244 of RA 8424, the authority to promulgate
the necessary rules and regulations for the effective enforcement of the provisions of the law.
Such authority is subject to the limitation that the rules and regulations must not override, but
must remain consistent and in harmony 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 have long recognized that the method of withholding tax at source is a procedure of
collecting income tax which is sanctioned by our tax laws.66 The withholding tax system was
devised for three primary reasons: first, to provide the taxpayer a convenient manner to meet
his probable income tax liability; second, to ensure the collection of income tax which can
otherwise be lost or substantially reduced through failure to file the corresponding returns and
third, to improve the government’s cash flow.67 This results in administrative savings, prompt
and efficient collection of taxes, prevention of delinquencies and reduction of governmental
effort to collect taxes through more complicated means and remedies.68

Respondent Secretary has the authority to require the withholding of a tax on items of income
payable to any person, national or juridical, residing in the Philippines. Such authority is derived
from Section 57(B) of RA 8424 which provides:

SEC. 57. Withholding of Tax at Source. –

xxx xxx xxx

(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 entity’s 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 agent’s 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 connection with the performance of his duties as a withholding agent.

No Blurring of Distinctions Between Ordinary Assets and Capital Assets

RR 2-98 imposes a graduated CWT on income based on the GSP or FMV of the real property
categorized as ordinary assets. On the other hand, Section 27(D)(5) of RA 8424 imposes a final
tax and flat rate of 6% on the gain presumed to be realized from the sale 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 final, show that
ordinary assets are not treated in the same manner as capital assets. Final withholding tax
(FWT) and CWT are distinguished as follows:

FWT CWT

a) The amount of income tax withheld a) Taxes withheld on certain income

by the withholding agent is constituted payments are intended to equal or at
as a full and final payment of the least approximate the tax due of the
income tax due from the payee on the payee on said income.
said income.
b)The liability for payment of the tax
rests primarily on the payor as a
withholding agent.
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 payee is not required to file an c) The income recipient is still required
income tax return for the particular to file an income tax return, as
income.73 prescribed in Sec. 51 and Sec. 52 of
the NIRC, as amended.74

As previously stated, FWT is imposed on the sale of capital assets. On the other hand, CWT is
imposed on the sale of ordinary assets. The inherent and substantial differences between FWT
and CWT disprove petitioner’s contention that ordinary assets are being lumped together with,
and treated similarly as, capital assets in contravention of the pertinent provisions of RA 8424.

Petitioner insists that the levy, collection and payment of CWT at the time of transaction are
contrary to the provisions of RA 8424 on the manner and time of filing of 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 FWT are distinct from
those of the CWT. The withholding agent/buyer’s act of collecting the tax at the time of the
transaction by withholding the tax due from the income payable is the essence of the
withholding tax method of tax collection.

No Rule that Only Passive

Incomes Can Be Subject to CWT

Petitioner submits that only passive income can be subjected to withholding 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. —

(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 corporation’s primary
purposes, the same is not passive income…76

It is income generated by the taxpayer’s 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 courts78 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.1avvphi1

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

Petitioner’s lamentations will not support its attack on the constitutionality of the CWT.
Petitioner’s 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 Petitioner’s 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 petitioner’s 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 Einstein’s 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.
G.R. No. 122605 April 30, 2001

SEA-LAND SERVICE, INC., petitioner,

vs.
COURT OF APPEALS and COMMISSIONER OF INTERNAL REVENUE, respondents.

PARDO, J.:

The Case

Appeal via certiorari from the decision of the Court of Appeals affirming in toto that of the Court
of Tax Appeals which denied petitioner’s claim for tax credit or refund of income tax paid on its
gross Philippine billings for taxable year 1984, in the amount of P870,093.12.1

The Facts

The facts, as found by the Court of Appeals, are as follows:

"Sea-Land Service Incorporated (SEA-LAND), an American international shipping

company licensed by the Securities and Exchange Commission to do business in
the Philippines entered into a contract with the United States Government to
transport military household goods and effects of U.S. military personnel
assigned to the Subic Naval Base.

"From the aforesaid contract, SEA-LAND derived an income for the taxable year
1984 amounting to P58,006,207.54. During the taxable year in question, SEA-
LAND filed with the Bureau of Internal Revenue (BIR) the corresponding
corporate Income Tax Return (ITR) and paid the income tax due thereon of 1.5%
as required in Section 25 (a)(2) of the National Internal Revenue Code (NIRC) in
relation to Article 9 of the RP-US Tax Treaty, amounting to P870,093.12.

"Claiming that it paid the aforementioned income tax by mistake, a written claim
for refund was filed with the BIR on 15 April 1987. However, before the said claim
for refund could be acted upon by public respondent Commissioner of Internal
Revenue, petitioner-appellant filed a petition for review with the CTA docketed as
CTA Case No. 4149, to judicially pursue its claim for refund and to stop the
running of the two-year prescriptive period under the then Section 243 of the
NIRC.

"On 21 February 1995, CTA rendered its decision denying SEA-LAND’s claim for
refund of the income tax it paid in 1984."2

On March 30, 1995, petitioner appealed the decision of the Court of Tax Appeals to the Court of
Appeals.3

After due proceedings, on October 26, 1995, the Court of Appeals promulgated its decision
dismissing the appeal and affirming in toto the decision of the Court of Tax Appeals.4
Hence, this petition.5

The Issue

The issue raised is whether or not the income that petitioner derived from services in
transporting the household goods and effects of U.S. military personnel falls within the tax
exemption provided in Article XII, paragraph 4 of the RP-US Military Bases Agreement.

The Court’s Ruling

We deny the petition.

The RP-US Military Bases Agreement provides:

"No national of the United States, or corporation organized under the laws of the
United States, shall be liable to pay income tax in the Philippines in respect of
any profits derived under a contract made in the United States with the
government of the United States in connection with the construction,
maintenance, operation and defense of the bases, or any tax in the nature of a
license in respect of any service or work for the United States in connection with
the construction, maintenance, operation and defense of the bases."6

Petitioner Sea-Land Service, Inc. a US shipping company licensed to do business in the

Philippines earned income during taxable year 1984 amounting to P58,006,207.54, and paid
income tax thereon of 1.5% amounting to P870,093.12.

The question is whether petitioner is exempted from the payment of income tax on its revenue
earned from the transport or shipment of household goods and effects of US personnel
assigned at Subic Naval Base.

"Laws granting exemption from tax are construed strictissimi juris against the taxpayer and
liberally in favor of the taxing power. Taxation is the rule and exemption is the exception."7 The
law "does not look with favor on tax exemptions and that he who would seek to be thus
privileged must justify it by words too plain to be mistaken and too categorical to be
misinterpreted."8

Under Article XII (4) of the RP-US Military Bases Agreement, the Philippine Government agreed
to exempt from payment of Philippine income tax nationals of the United States, or corporations
organized under the laws of the United States, residents in the United States in respect of any
profit derived under a contract made in the United States with the Government of the United
States in connection with the construction, maintenance, operation and defense of the
bases.

It is obvious that the transport or shipment of household goods and effects of U.S. military
personnel is not included in the term "construction, maintenance, operation and defense of the
bases." Neither could the performance of this service to the U.S. government be interpreted as
directly related to the defense and security of the Philippine territories. "When the law speaks in
clear and categorical language, there is no reason for interpretation or construction, but only for
application."9 Any interpretation that would give it an expansive construction to encompass
petitioner’s exemption from taxation would be unwarranted.
The avowed purpose of tax exemption "is some public benefit or interest, which the lawmaking
body considers sufficient to offset the monetary loss entailed in the grant of the exemption."10
The hauling or transport of household goods and personal effects of U. S. military personnel
would not directly contribute to the defense and security of the Philippines.

We see no reason to reverse the ruling of the Court of Appeals, which affirmed the decision of
the Court of Tax Appeals. The Supreme "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 an expertise on the subject,
unless there has been an abuse or improvident exercise of authority."11

Hence, the Court of Appeals did not err or gravely abuse its discretion in dismissing the petition
for review. We can not grant the petition.1âwphi1.nêt

The Judgment

WHEREFORE, the Court DENIES the petition for lack of merit.

No costs.

SO ORDERED
G.R. No. 188550 August 19, 2013

DEUTSCHE BANK AG MANILA BRANCH, PETITIONER,

vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DECISION

SERENO, CJ.:

This is a Petition for Review1 filed by Deutsche Bank AG Manila Branch (petitioner) under Rule
45 of the 1997 Rules of Civil Procedure assailing the Court of Tax Appeals En Banc (CTA En
Banc) Decision2 dated 29 May 2009 and Resolution3 dated 1 July 2009 in C.T.A. EB No. 456.

THE FACTS

In accordance with Section 28(A)(5)4 of the National Internal Revenue Code (NIRC) of 1997,
petitioner withheld and remitted to respondent on 21 October 2003 the amount of PHP
67,688,553.51, which represented the fifteen percent (15%) branch profit remittance tax (BPRT)
on its regular banking unit (RBU) net income remitted to Deutsche Bank Germany (DB
Germany) for 2002 and prior taxable years.5

Believing that it made an overpayment of the BPRT, petitioner filed with the BIR Large
Taxpayers Assessment and Investigation Division on 4 October 2005 an administrative claim for
refund or issuance of its tax credit certificate in the total amount of PHP 22,562,851.17. On the
same date, petitioner requested from the International Tax Affairs Division (ITAD) a confirmation
of its entitlement to the preferential tax rate of 10% under the RP-Germany Tax Treaty.6

Alleging the inaction of the BIR on its administrative claim, petitioner filed a Petition for Review7
with the CTA on 18 October 2005. Petitioner reiterated its claim for the refund or issuance of its
tax credit certificate for the amount of PHP 22,562,851.17 representing the alleged excess
BPRT paid on branch profits remittance to DB Germany.

THE CTA SECOND DIVISION RULING8

After trial on the merits, the CTA Second Division found that petitioner indeed paid the total
amount of PHP 67,688,553.51 representing the 15% BPRT on its RBU profits amounting to
PHP 451,257,023.29 for 2002 and prior taxable years. Records also disclose that for the year
2003, petitioner remitted to DB Germany the amount of EURO 5,174,847.38 (or PHP
330,175,961.88 at the exchange rate of PHP 63.804:1 EURO), which is net of the 15% BPRT.

However, the claim of petitioner for a refund was denied on the ground that the application for a
tax treaty relief was not filed with ITAD prior to the payment by the former of its BPRT and actual
remittance of its branch profits to DB Germany, or prior to its availment of the preferential rate of
ten percent (10%) under the RP-Germany Tax Treaty provision. The court a quo held that
petitioner violated the fifteen (15) day period mandated under Section III paragraph (2) of
Revenue Memorandum Order (RMO) No. 1-2000.
Further, the CTA Second Division relied on Mirant (Philippines) Operations Corporation
(formerly Southern Energy Asia-Pacific Operations [Phils.], Inc.) v. Commissioner of Internal
Revenue9 (Mirant) where the CTA En Banc ruled that before the benefits of the tax treaty may
be extended to a foreign corporation wishing to avail itself thereof, the latter should first invoke
the provisions of the tax treaty and prove that they indeed apply to the corporation.

THE CTA EN BANC RULING10

The CTA En Banc affirmed the CTA Second Division’s Decision dated 29 August 2008 and
Resolution dated 14 January 2009. Citing Mirant, the CTA En Banc held that a ruling from the
ITAD of the BIR must be secured prior to the availment of a preferential tax rate under a tax
treaty. Applying the principle of stare decisis et non quieta movere, the CTA En Banc took into
consideration that this Court had denied the Petition in G.R. No. 168531 filed by Mirant for
failure to sufficiently show any reversible error in the assailed judgment.11 The CTA En Banc
ruled that once a case has been decided in one way, any other case involving exactly the same
point at issue should be decided in the same manner.

The court likewise ruled that the 15-day rule for tax treaty relief application under RMO No. 1-
2000 cannot be relaxed for petitioner, unlike in CBK Power Company Limited v. Commissioner
of Internal Revenue.12 In that case, the rule was relaxed and the claim for refund of excess final
withholding taxes was partially granted. While it issued a ruling to CBK Power Company Limited
after the payment of withholding taxes, the ITAD did not issue any ruling to petitioner even if it
filed a request for confirmation on 4 October 2005 that the remittance of branch profits to DB
Germany is subject to a preferential tax rate of 10% pursuant to Article 10 of the RP-Germany
Tax Treaty.

ISSUE

This Court is now confronted with the issue of whether the failure to strictly comply with RMO
No. 1-2000 will deprive persons or corporations of the benefit of a tax treaty.

THE COURT’S RULING

The Petition is meritorious.

Under Section 28(A)(5) of the NIRC, any profit remitted to its head office shall be subject to a
tax of 15% based on the total profits applied for or earmarked for remittance without any
deduction of the tax component. However, petitioner invokes paragraph 6, Article 10 of the RP-
Germany Tax Treaty, which provides that where a resident of the Federal Republic of Germany
has a branch in the Republic of the Philippines, this branch may be subjected to the branch
profits remittance tax withheld at source in accordance with Philippine law but shall not exceed
10% of the gross amount of the profits remitted by that branch to the head office.

By virtue of the RP-Germany Tax Treaty, we are bound to extend to a branch in the Philippines,
remitting to its head office in Germany, the benefit of a preferential rate equivalent to 10% BPRT.

On the other hand, the BIR issued RMO No. 1-2000, which requires that any availment of the
tax treaty relief must be preceded by an application with ITAD at least 15 days before the
transaction. The Order was issued to streamline the processing of the application of tax treaty
relief in order to improve efficiency and service to the taxpayers. Further, it also aims to prevent
the consequences of an erroneous interpretation and/or application of the treaty provisions (i.e.,
filing a claim for a tax refund/credit for the overpayment of taxes or for deficiency tax liabilities
for underpayment).13

The crux of the controversy lies in the implementation of RMO No. 1-2000.

Petitioner argues that, considering that it has met all the conditions under Article 10 of the RP-
Germany Tax Treaty, the CTA erred in denying its claim solely on the basis of RMO No. 1-2000.
The filing of a tax treaty relief application is not a condition precedent to the availment of a
preferential tax rate. Further, petitioner posits that, contrary to the ruling of the CTA, Mirant is not
a binding judicial precedent to deny a claim for refund solely on the basis of noncompliance with
RMO No. 1-2000.

Respondent counters that the requirement of prior application under RMO No. 1-2000 is
mandatory in character. RMO No. 1-2000 was issued pursuant to the unquestioned authority of
the Secretary of Finance to promulgate rules and regulations for the effective implementation of
the NIRC. Thus, courts cannot ignore administrative issuances which partakes the nature of a
statute and have in their favor a presumption of legality.

The CTA ruled that prior application for a tax treaty relief is mandatory, and noncompliance with
this prerequisite is fatal to the taxpayer’s availment of the preferential tax rate.

We disagree.

A minute resolution is not a binding precedent

At the outset, this Court’s minute resolution on Mirant is not a binding precedent. The Court has
clarified this matter in Philippine Health Care Providers, Inc. v. Commissioner of Internal
Revenue14 as follows:

It is true that, although contained in a minute resolution, our dismissal of the petition was a
disposition of the merits of the case. When we dismissed the petition, we effectively affirmed the
CA ruling being questioned. As a result, our ruling in that case has already become final. When
a minute resolution denies or dismisses a petition for failure to comply with formal and
substantive requirements, the challenged decision, together with its findings of fact and legal
conclusions, are deemed sustained. But what is its effect on other cases?

With respect to the same subject matter and the same issues concerning the same parties, it
constitutes res judicata. However, if other parties or another subject matter (even with the same
parties and issues) is involved, the minute resolution is not binding precedent. Thus, in CIR v.
Baier-Nickel, the Court noted that a previous case, CIR v. Baier-Nickel involving the same
parties and the same issues, was previously disposed of by the Court thru a minute resolution
dated February 17, 2003 sustaining the ruling of the CA. Nonetheless, the Court ruled that the
previous case "ha(d) no bearing" on the latter case because the two cases involved different
subject matters as they were concerned with the taxable income of different taxable years.

Besides, there are substantial, not simply formal, distinctions between a minute resolution and a
decision. The constitutional requirement under the first paragraph of Section 14, Article VIII of
the Constitution that the facts and the law on which the judgment is based must be expressed
clearly and distinctly applies only to decisions, not to minute resolutions. A minute resolution is
signed only by the clerk of court by authority of the justices, unlike a decision. It does not require
the certification of the Chief Justice. Moreover, unlike decisions, minute resolutions are not
published in the Philippine Reports. Finally, the proviso of Section 4(3) of Article VIII speaks of a
decision. Indeed, as a rule, this Court lays down doctrines or principles of law which constitute
binding precedent in a decision duly signed by the members of the Court and certified by the
Chief Justice. (Emphasis supplied)

Even if we had affirmed the CTA in Mirant, the doctrine laid down in that Decision cannot bind
this Court in cases of a similar nature. There are differences in parties, taxes, taxable periods,
and treaties involved; more importantly, the disposition of that case was made only through a
minute resolution.

Tax Treaty vs. RMO No. 1-2000

Our Constitution provides for adherence to the general principles of international law as part of
the law of the land.15 The time-honored international principle of pacta sunt servanda demands
the performance in good faith of treaty obligations on the part of the states that enter into the
agreement. Every treaty in force is binding upon the parties, and obligations under the treaty
must be performed by them in good faith.16 More importantly, treaties have the force and effect
of law in this jurisdiction.17

Tax treaties are entered into "to reconcile the national fiscal legislations of the contracting
parties and, in turn, help the taxpayer avoid simultaneous taxations in two different
jurisdictions."18 CIR v. S.C. Johnson and Son, Inc. further clarifies that "tax conventions are
drafted with a view towards the elimination of international juridical double taxation, which is
defined as the imposition of comparable taxes in two or more states on the same taxpayer in
respect of the same subject matter and for identical periods. The apparent rationale for doing
away with double taxation is to encourage the free flow of goods and services and the
movement of capital, technology and persons between countries, conditions deemed vital in
creating robust and dynamic economies. Foreign investments will only thrive in a fairly
predictable and reasonable international investment climate and the protection against double
taxation is crucial in creating such a climate."19

Simply put, tax treaties are entered into to minimize, if not eliminate the harshness of
international juridical double taxation, which is why they are also known as double tax treaty or
double tax agreements.

"A state that has contracted valid international obligations is bound to make in its legislations
those modifications that may be necessary to ensure the fulfillment of the obligations
undertaken."20 Thus, laws and issuances must ensure that the reliefs granted under tax treaties
are accorded to the parties entitled thereto. The BIR must not impose additional requirements
that would negate the availment of the reliefs provided for under international agreements. More
so, when the RP-Germany Tax Treaty does not provide for any pre-requisite for the availment of
the benefits under said agreement.

Likewise, it must be stressed that there is nothing in RMO No. 1-2000 which would indicate a
deprivation of entitlement to a tax treaty relief for failure to comply with the 15-day period. We
recognize the clear intention of the BIR in implementing RMO No. 1-2000, but the CTA’s outright
denial of a tax treaty relief for failure to strictly comply with the prescribed period is not in
harmony with the objectives of the contracting state to ensure that the benefits granted under
tax treaties are enjoyed by duly entitled persons or corporations.

Bearing in mind the rationale of tax treaties, the period of application for the availment of tax
treaty relief as required by RMO No. 1-2000 should not operate to divest entitlement to the relief
as it would constitute a violation of the duty required by good faith in complying with a tax treaty.
The denial of the availment of tax relief for the failure of a taxpayer to apply within the
prescribed period under the administrative issuance would impair the value of the tax treaty. At
most, the application for a tax treaty relief from the BIR should merely operate to confirm the
entitlement of the taxpayer to the relief.

The obligation to comply with a tax treaty must take precedence over the objective of RMO No.
1-2000.1âwphi1 Logically, noncompliance with tax treaties has negative implications on
international relations, and unduly discourages foreign investors. While the consequences
sought to be prevented by RMO No. 1-2000 involve an administrative procedure, these may be
remedied through other system management processes, e.g., the imposition of a fine or penalty.
But we cannot totally deprive those who are entitled to the benefit of a treaty for failure to strictly
comply with an administrative issuance requiring prior application for tax treaty relief.

Prior Application vs. Claim for Refund

Again, RMO No. 1-2000 was implemented to obviate any erroneous interpretation and/or
application of the treaty provisions. The objective of the BIR is to forestall assessments against
corporations who erroneously availed themselves of the benefits of the tax treaty but are not
legally entitled thereto, as well as to save such investors from the tedious process of claims for
a refund due to an inaccurate application of the tax treaty provisions. However, as earlier
discussed, noncompliance with the 15-day period for prior application should not operate to
automatically divest entitlement to the tax treaty relief especially in claims for refund.

The underlying principle of prior application with the BIR becomes moot in refund cases, such
as the present case, where the very basis of the claim is erroneous or there is excessive
payment arising from non-availment of a tax treaty relief at the first instance. In this case,
petitioner should not be faulted for not complying with RMO No. 1-2000 prior to the transaction.
It could not have applied for a tax treaty relief within the period prescribed, or 15 days prior to
the payment of its BPRT, precisely because it erroneously paid the BPRT not on the basis of the
preferential tax rate under

the RP-Germany Tax Treaty, but on the regular rate as prescribed by the NIRC. Hence, the prior
application requirement becomes illogical. Therefore, the fact that petitioner invoked the
provisions of the RP-Germany Tax Treaty when it requested for a confirmation from the ITAD
before filing an administrative claim for a refund should be deemed substantial compliance with
RMO No. 1-2000.

Corollary thereto, Section 22921 of the NIRC provides the taxpayer a remedy for tax recovery
when there has been an erroneous payment of tax.1âwphi1 The outright denial of petitioner’s
claim for a refund, on the sole ground of failure to apply for a tax treaty relief prior to the
payment of the BPRT, would defeat the purpose of Section 229.

Petitioner is entitled to a refund

It is significant to emphasize that petitioner applied – though belatedly – for a tax treaty relief, in
substantial compliance with RMO No. 1-2000. A ruling by the BIR would have confirmed
whether petitioner was entitled to the lower rate of 10% BPRT pursuant to the RP-Germany Tax
Treaty.

Nevertheless, even without the BIR ruling, the CTA Second Division found as follows:

Based on the evidence presented, both documentary and testimonial, petitioner was able to
establish the following facts:

a. That petitioner is a branch office in the Philippines of Deutsche Bank AG, a

corporation organized and existing under the laws of the Federal Republic of Germany;

b. That on October 21, 2003, it filed its Monthly Remittance Return of Final Income
Taxes Withheld under BIR Form No. 1601-F and remitted the amount of ₱67,688,553.51
as branch profits remittance tax with the BIR; and

c. That on October 29, 2003, the Bangko Sentral ng Pilipinas having issued a clearance,
petitioner remitted to Frankfurt Head Office the amount of EUR5,174,847.38 (or
₱330,175,961.88 at 63.804 Peso/Euro) representing its 2002 profits remittance.22

The amount of PHP 67,688,553.51 paid by petitioner represented the 15% BPRT on its RBU net
income, due for remittance to DB Germany amounting to PHP 451,257,023.29 for 2002 and
prior taxable years.23

Likewise, both the administrative and the judicial actions were filed within the two-year
prescriptive period pursuant to Section 229 of the NIRC.24

Clearly, there is no reason to deprive petitioner of the benefit of a preferential tax rate of 10%
BPRT in accordance with the RP-Germany Tax Treaty.

Petitioner is liable to pay only the amount of PHP 45,125,702.34 on its RBU net income
amounting to PHP 451,257,023.29 for 2002 and prior taxable years, applying the 10% BPRT.
Thus, it is proper to grant petitioner a refund ofthe difference between the PHP 67,688,553.51
(15% BPRT) and PHP 45,125,702.34 (10% BPRT) or a total of PHP 22,562,851.17.

WHEREFORE, premises considered, the instant Petition is GRANTED. Accordingly, the Court
of Tax Appeals En Banc Decision dated 29 May 2009 and Resolution dated 1 July 2009 are
REVERSED and SET ASIDE. A new one is hereby entered ordering respondent Commissioner
of Internal Revenue to refund or issue a tax credit certificate in favor of petitioner Deutsche
Bank AG Manila Branch the amount of TWENTY TWO MILLION FIVE HUNDRED SIXTY TWO
THOUSAND EIGHT HUNDRED FIFTY ONE PESOS AND SEVENTEEN CENTAVOS (PHP
22,562,851.17), Philippine currency, representing the erroneously paid BPRT for 2002 and prior
taxable years.

SO ORDERED.
G.R. No. 195909 September 26, 2012

COMMISSIONER OF INTERNAL REVENUE, PETITIONER,

vs.
ST. LUKE'S MEDICAL CENTER, INC., RESPONDENT.

x-----------------------x

G.R. No. 195960

ST. LUKE'S MEDICAL CENTER, INC., PETITIONER,

vs.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DECISION

CARPIO, J.:

The Case

These are consolidated 1 petitions for review on certiorari under Rule 45 of the Rules of Court
assailing the Decision of 19 November 2010 of the Court of Tax Appeals (CTA) En Banc and its
Resolution 2 of 1 March 2011 in CTA Case No. 6746. This Court resolves this case on a pure
question of law, which involves the interpretation of Section 27(B) vis-à-vis Section 30(E) and
(G) of the National Internal Revenue Code of the Philippines (NIRC), on the income tax
treatment of proprietary non-profit hospitals.

The Facts

St. Luke's Medical Center, Inc. (St. Luke's) is a hospital organized as a non-stock and non-profit
corporation. Under its articles of incorporation, among its corporate purposes are:

(a) To establish, equip, operate and maintain a non-stock, non-profit Christian,

benevolent, charitable and scientific hospital which shall give curative, rehabilitative and
spiritual care to the sick, diseased and disabled persons; provided that purely medical and
surgical services shall be performed by duly licensed physicians and surgeons who may
be freely and individually contracted by patients;

(b) To provide a career of health science education and provide medical services to the
community through organized clinics in such specialties as the facilities and resources of
the corporation make possible;

(c) To carry on educational activities related to the maintenance and promotion of health
as well as provide facilities for scientific and medical researches which, in the opinion of
 the Board of Trustees, may be justified by the facilities, personnel, funds, or other
requirements that are available;

(d) To cooperate with organized medical societies, agencies of both government and
private sector; establish rules and regulations consistent with the highest professional
ethics;

xxxx3

On 16 December 2002, the Bureau of Internal Revenue (BIR) assessed St. Luke's deficiency
taxes amounting to ₱76,063,116.06 for 1998, comprised of deficiency income tax, value-added
tax, withholding tax on compensation and expanded withholding tax. The BIR reduced the
amount to ₱63,935,351.57 during trial in the First Division of the CTA. 4

On 14 January 2003, St. Luke's filed an administrative protest with the BIR against the
deficiency tax assessments. The BIR did not act on the protest within the 180-day period under
Section 228 of the NIRC. Thus, St. Luke's appealed to the CTA.

The BIR argued before the CTA that Section 27(B) of the NIRC, which imposes a 10%
preferential tax rate on the income of proprietary non-profit hospitals, should be applicable to St.
Luke's. According to the BIR, Section 27(B), introduced in 1997, "is a new provision intended to
amend the exemption on non-profit hospitals that were previously categorized as non-stock, non-
profit corporations under Section 26 of the 1997 Tax Code x x x." 5 It is a specific provision
which prevails over the general exemption on income tax granted under Section 30(E) and (G)
for non-stock, non-profit charitable institutions and civic organizations promoting social welfare.
6

The BIR claimed that St. Luke's was actually operating for profit in 1998 because only 13% of
its revenues came from charitable purposes. Moreover, the hospital's board of trustees, officers
and employees directly benefit from its profits and assets. St. Luke's had total revenues of
₱1,730,367,965 or approximately ₱1.73 billion from patient services in 1998. 7

St. Luke's contended that the BIR should not consider its total revenues, because its free services
to patients was ₱218,187,498 or 65.20% of its 1998 operating income (i.e., total revenues less
operating expenses) of ₱334,642,615. 8 St. Luke's also claimed that its income does not inure to
the benefit of any individual.

St. Luke's maintained that it is a non-stock and non-profit institution for charitable and social
welfare purposes under Section 30(E) and (G) of the NIRC. It argued that the making of profit
per se does not destroy its income tax exemption.

The petition of the BIR before this Court in G.R. No. 195909 reiterates its arguments before the
CTA that Section 27(B) applies to St. Luke's. The petition raises the sole issue of whether the
enactment of Section 27(B) takes proprietary non-profit hospitals out of the income tax
exemption under Section 30 of the NIRC and instead, imposes a preferential rate of 10% on their
taxable income. The BIR prays that St. Luke's be ordered to pay ₱57,659,981.19 as deficiency
income and expanded withholding tax for 1998 with surcharges and interest for late payment.

The petition of St. Luke's in G.R. No. 195960 raises factual matters on the treatment and
withholding of a part of its income, 9 as well as the payment of surcharge and delinquency
interest. There is no ground for this Court to undertake such a factual review. Under the
Constitution 10 and the Rules of Court, 11 this Court's review power is generally limited to
"cases in which only an error or question of law is involved." 12 This Court cannot depart from
this limitation if a party fails to invoke a recognized exception.

The Ruling of the Court of Tax Appeals

The CTA En Banc Decision on 19 November 2010 affirmed in toto the CTA First Division
Decision dated 23 February 2009 which held:

WHEREFORE, the Amended Petition for Review [by St. Luke's] is hereby PARTIALLY
GRANTED. Accordingly, the 1998 deficiency VAT assessment issued by respondent against
petitioner in the amount of ₱110,000.00 is hereby CANCELLED and WITHDRAWN. However,
petitioner is hereby ORDERED to PAY deficiency income tax and deficiency expanded
withholding tax for the taxable year 1998 in the respective amounts of ₱5,496,963.54 and
₱778,406.84 or in the sum of ₱6,275,370.38, x x x.

xxxx

In addition, petitioner is hereby ORDERED to PAY twenty percent (20%) delinquency interest
on the total amount of ₱6,275,370.38 counted from October 15, 2003 until full payment thereof,
pursuant to Section 249(C)(3) of the NIRC of 1997.

SO ORDERED. 13

The deficiency income tax of ₱5,496,963.54, ordered by the CTA En Banc to be paid, arose from
the failure of St. Luke's to prove that part of its income in 1998 (declared as "Other Income-Net")
14 came from charitable activities. The CTA cancelled the remainder of the ₱63,113,952.79
deficiency assessed by the BIR based on the 10% tax rate under Section 27(B) of the NIRC,
which the CTA En Banc held was not applicable to St. Luke's. 15

The CTA ruled that St. Luke's is a non-stock and non-profit charitable institution covered by
Section 30(E) and (G) of the NIRC. This ruling would exempt all income derived by St. Luke's
from services to its patients, whether paying or non-paying. The CTA reiterated its earlier
decision in St. Luke's Medical Center, Inc. v. Commissioner of Internal Revenue, 16 which
examined the primary purposes of St. Luke's under its articles of incorporation and various
documents 17 identifying St. Luke's as a charitable institution.

The CTA adopted the test in Hospital de San Juan de Dios, Inc. v. Pasay City, 18 which states
that "a charitable institution does not lose its charitable character and its consequent exemption
from taxation merely because recipients of its benefits who are able to pay are required to do so,
where funds derived in this manner are devoted to the charitable purposes of the institution x x
x." 19 The generation of income from paying patients does not per se destroy the charitable
nature of St. Luke's.

Hospital de San Juan cited Jesus Sacred Heart College v. Collector of Internal Revenue, 20
which ruled that the old NIRC (Commonwealth Act No. 466, as amended) 21 "positively
exempts from taxation those corporations or associations which, otherwise, would be subject
thereto, because of the existence of x x x net income." 22 The NIRC of 1997 substantially
reproduces the provision on charitable institutions of the old NIRC. Thus, in rejecting the
argument that tax exemption is lost whenever there is net income, the Court in Jesus Sacred
Heart College declared: "[E]very responsible organization must be run to at least insure its
existence, by operating within the limits of its own resources, especially its regular income. In
other words, it should always strive, whenever possible, to have a surplus." 23

The CTA held that Section 27(B) of the present NIRC does not apply to St. Luke's. 24 The CTA
explained that to apply the 10% preferential rate, Section 27(B) requires a hospital to be "non-
profit." On the other hand, Congress specifically used the word "non-stock" to qualify a
charitable "corporation or association" in Section 30(E) of the NIRC. According to the CTA, this
is unique in the present tax code, indicating an intent to exempt this type of charitable
organization from income tax. Section 27(B) does not require that the hospital be "non-stock."
The CTA stated, "it is clear that non-stock, non-profit hospitals operated exclusively for
charitable purpose are exempt from income tax on income received by them as such, applying
the provision of Section 30(E) of the NIRC of 1997, as amended." 25

The Issue

The sole issue is whether St. Luke's is liable for deficiency income tax in 1998 under Section
27(B) of the NIRC, which imposes a preferential tax rate of 10% on the income of proprietary
non-profit hospitals.

The Ruling of the Court

St. Luke's Petition in G.R. No. 195960

As a preliminary matter, this Court denies the petition of St. Luke's in G.R. No. 195960 because
the petition raises factual issues. Under Section 1, Rule 45 of the Rules of Court, "[t]he petition
shall raise only questions of law which must be distinctly set forth." St. Luke's cites Martinez v.
Court of Appeals 26 which permits factual review "when the Court of Appeals [in this case, the
CTA] manifestly overlooked certain relevant facts not disputed by the parties and which, if
properly considered, would justify a different conclusion." 27

This Court does not see how the CTA overlooked relevant facts. St. Luke's itself stated that the
CTA "disregarded the testimony of [its] witness, Romeo B. Mary, being allegedly self-serving, to
show the nature of the 'Other Income-Net' x x x." 28 This is not a case of overlooking or failing
to consider relevant evidence. The CTA obviously considered the evidence and concluded that it
is self-serving. The CTA declared that it has "gone through the records of this case and found no
other evidence aside from the self-serving affidavit executed by [the] witnesses [of St. Luke's] x
x x." 29

The deficiency tax on "Other Income-Net" stands. Thus, St. Luke's is liable to pay the 25%
surcharge under Section 248(A)(3) of the NIRC. There is "[f]ailure to pay the deficiency tax
within the time prescribed for its payment in the notice of assessment[.]" 30 St. Luke's is also
liable to pay 20% delinquency interest under Section 249(C)(3) of the NIRC. 31 As explained by
the CTA En Banc, the amount of ₱6,275,370.38 in the dispositive portion of the CTA First
Division Decision includes only deficiency interest under Section 249(A) and (B) of the NIRC
and not delinquency interest. 32

The Main Issue

The issue raised by the BIR is a purely legal one. It involves the effect of the introduction of
Section 27(B) in the NIRC of 1997 vis-à-vis Section 30(E) and (G) on the income tax exemption
of charitable and social welfare institutions. The 10% income tax rate under Section 27(B)
specifically pertains to proprietary educational institutions and proprietary non-profit hospitals.
The BIR argues that Congress intended to remove the exemption that non-profit hospitals
previously enjoyed under Section 27(E) of the NIRC of 1977, which is now substantially
reproduced in Section 30(E) of the NIRC of 1997. 33 Section 27(B) of the present NIRC
provides:

SEC. 27. Rates of Income Tax on Domestic Corporations. -

xxxx

(B) Proprietary Educational Institutions and Hospitals. - Proprietary educational institutions and
hospitals which are non-profit shall pay a tax of ten percent (10%) on their taxable income
except those covered by Subsection (D) hereof: Provided, That if the gross income from
unrelated trade, business or other activity exceeds fifty percent (50%) of the total gross income
derived by such educational institutions or hospitals from all sources, the tax prescribed in
Subsection (A) hereof shall be imposed on the entire taxable income. For purposes of this
Subsection, the term 'unrelated trade, business or other activity' means any trade, business or
other activity, the conduct of which is not substantially related to the exercise or performance by
such educational institution or hospital of its primary purpose or function. A 'proprietary
educational institution' is any private school maintained and administered by private individuals
or groups with an issued permit to operate from the Department of Education, Culture and Sports
(DECS), or the Commission on Higher Education (CHED), or the Technical Education and Skills
Development Authority (TESDA), as the case may be, in accordance with existing laws and
regulations. (Emphasis supplied)

St. Luke's claims tax exemption under Section 30(E) and (G) of the NIRC. It contends that it is a
charitable institution and an organization promoting social welfare. The arguments of St. Luke's
focus on the wording of Section 30(E) exempting from income tax non-stock, non-profit
charitable institutions. 34 St. Luke's asserts that the legislative intent of introducing Section
27(B) was only to remove the exemption for "proprietary non-profit" hospitals. 35 The relevant
provisions of Section 30 state:

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not be taxed
under this Title in respect to income received by them as such:

xxxx

(E) Nonstock corporation or association organized and operated exclusively for religious,
charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of
its net income or asset shall belong to or inure to the benefit of any member, organizer, officer or
any specific person;

xxxx

(G) Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;

xxxx

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and
character of the foregoing organizations from any of their properties, real or personal, or from
any of their activities conducted for profit regardless of the disposition made of such income,
shall be subject to tax imposed under this Code. (Emphasis supplied)

The Court partly grants the petition of the BIR but on a different ground. We hold that Section
27(B) of the NIRC does not remove the income tax exemption of proprietary non-profit hospitals
under Section 30(E) and (G). Section 27(B) on one hand, and Section 30(E) and (G) on the other
hand, can be construed together without the removal of such tax exemption. The effect of the
introduction of Section 27(B) is to subject the taxable income of two specific institutions,
namely, proprietary non-profit educational institutions 36 and proprietary non-profit hospitals,
among the institutions covered by Section 30, to the 10% preferential rate under Section 27(B)
instead of the ordinary 30% corporate rate under the last paragraph of Section 30 in relation to
Section 27(A)(1).

Section 27(B) of the NIRC imposes a 10% preferential tax rate on the income of (1) proprietary
non-profit educational institutions and (2) proprietary non-profit hospitals. The only
qualifications for hospitals are that they must be proprietary and non-profit. "Proprietary" means
private, following the definition of a "proprietary educational institution" as "any private school
maintained and administered by private individuals or groups" with a government permit. "Non-
profit" means no net income or asset accrues to or benefits any member or specific person, with
all the net income or asset devoted to the institution's purposes and all its activities conducted not
for profit.

"Non-profit" does not necessarily mean "charitable." In Collector of Internal Revenue v. Club
Filipino Inc. de Cebu, 37 this Court considered as non-profit a sports club organized for
recreation and entertainment of its stockholders and members. The club was primarily funded by
membership fees and dues. If it had profits, they were used for overhead expenses and improving
its golf course. 38 The club was non-profit because of its purpose and there was no evidence that
it was engaged in a profit-making enterprise. 39

The sports club in Club Filipino Inc. de Cebu may be non-profit, but it was not charitable. The
Court defined "charity" in Lung Center of the Philippines v. Quezon City 40 as "a gift, to be
applied consistently with existing laws, for the benefit of an indefinite number of persons, either
by bringing their minds and hearts under the influence of education or religion, by assisting them
to establish themselves in life or [by] otherwise lessening the burden of government." 41 A non-
profit club for the benefit of its members fails this test. An organization may be considered as
non-profit if it does not distribute any part of its income to stockholders or members. However,
despite its being a tax exempt institution, any income such institution earns from activities
conducted for profit is taxable, as expressly provided in the last paragraph of Section 30.

To be a charitable institution, however, an organization must meet the substantive test of charity
in Lung Center. The issue in Lung Center concerns exemption from real property tax and not
income tax. However, it provides for the test of charity in our jurisdiction. Charity is essentially a
gift to an indefinite number of persons which lessens the burden of government. In other words,
charitable institutions provide for free goods and services to the public which would otherwise
fall on the shoulders of government. Thus, as a matter of efficiency, the government forgoes
taxes which should have been spent to address public needs, because certain private entities
already assume a part of the burden. This is the rationale for the tax exemption of charitable
institutions. The loss of taxes by the government is compensated by its relief from doing public
works which would have been funded by appropriations from the Treasury. 42

Charitable institutions, however, are not ipso facto entitled to a tax exemption. The requirements
for a tax exemption are specified by the law granting it. The power of Congress to tax implies the
power to exempt from tax. Congress can create tax exemptions, subject to the constitutional
provision that "[n]o law granting any tax exemption shall be passed without the concurrence of a
majority of all the Members of Congress." 43 The requirements for a tax exemption are strictly
construed against the taxpayer 44 because an exemption restricts the collection of taxes
necessary for the existence of the government.

The Court in Lung Center declared that the Lung Center of the Philippines is a charitable
institution for the purpose of exemption from real property taxes. This ruling uses the same
premise as Hospital de San Juan 45 and Jesus Sacred Heart College 46 which says that receiving
income from paying patients does not destroy the charitable nature of a hospital.

As a general principle, a charitable institution does not lose its character as such and its
exemption from taxes simply because it derives income from paying patients, whether out-
patient, or confined in the hospital, or receives subsidies from the government, so long as the
money received is devoted or used altogether to the charitable object which it is intended to
achieve; and no money inures to the private benefit of the persons managing or operating the
institution. 47
For real property taxes, the incidental generation of income is permissible because the test of
exemption is the use of the property. The Constitution provides that "[c]haritable institutions,
churches and personages or convents appurtenant thereto, mosques, non-profit cemeteries, and
all lands, buildings, and improvements, actually, directly, and exclusively used for religious,
charitable, or educational purposes shall be exempt from taxation." 48 The test of exemption is
not strictly a requirement on the intrinsic nature or character of the institution. The test requires
that the institution use the property in a certain way, i.e. for a charitable purpose. Thus, the Court
held that the Lung Center of the Philippines did not lose its charitable character when it used a
portion of its lot for commercial purposes. The effect of failing to meet the use requirement is
simply to remove from the tax exemption that portion of the property not devoted to charity.

The Constitution exempts charitable institutions only from real property taxes. In the NIRC,
Congress decided to extend the exemption to income taxes. However, the way Congress crafted
Section 30(E) of the NIRC is materially different from Section 28(3), Article VI of the
Constitution. Section 30(E) of the NIRC defines the corporation or association that is exempt
from income tax. On the other hand, Section 28(3), Article VI of the Constitution does not define
a charitable institution, but requires that the institution "actually, directly and exclusively" use the
property for a charitable purpose.

Section 30(E) of the NIRC provides that a charitable institution must be:

(1) A non-stock corporation or association;

(2) Organized exclusively for charitable purposes;

(3) Operated exclusively for charitable purposes; and

(4) No part of its net income or asset shall belong to or inure to the benefit of any
member, organizer, officer or any specific person.

Thus, both the organization and operations of the charitable institution must be devoted
"exclusively" for charitable purposes. The organization of the institution refers to its corporate
form, as shown by its articles of incorporation, by-laws and other constitutive documents.
Section 30(E) of the NIRC specifically requires that the corporation or association be non-stock,
which is defined by the Corporation Code as "one where no part of its income is distributable as
dividends to its members, trustees, or officers" 49 and that any profit "obtain[ed] as an incident
to its operations shall, whenever necessary or proper, be used for the furtherance of the purpose
or purposes for which the corporation was organized." 50 However, under Lung Center, any
profit by a charitable institution must not only be plowed back "whenever necessary or proper,"
but must be "devoted or used altogether to the charitable object which it is intended to achieve."
51

The operations of the charitable institution generally refer to its regular activities. Section 30(E)
of the NIRC requires that these operations be exclusive to charity. There is also a specific
requirement that "no part of [the] net income or asset shall belong to or inure to the benefit of
any member, organizer, officer or any specific person." The use of lands, buildings and
improvements of the institution is but a part of its operations.

There is no dispute that St. Luke's is organized as a non-stock and non-profit charitable
institution. However, this does not automatically exempt St. Luke's from paying taxes. This only
refers to the organization of St. Luke's. Even if St. Luke's meets the test of charity, a charitable
institution is not ipso facto tax exempt. To be exempt from real property taxes, Section 28(3),
Article VI of the Constitution requires that a charitable institution use the property "actually,
directly and exclusively" for charitable purposes. To be exempt from income taxes, Section
30(E) of the NIRC requires that a charitable institution must be "organized and operated
exclusively" for charitable purposes. Likewise, to be exempt from income taxes, Section 30(G)
of the NIRC requires that the institution be "operated exclusively" for social welfare.

However, the last paragraph of Section 30 of the NIRC qualifies the words "organized and
operated exclusively" by providing that:

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and
character of the foregoing organizations from any of their properties, real or personal, or from
any of their activities conducted for profit regardless of the disposition made of such income,
shall be subject to tax imposed under this Code. (Emphasis supplied)

In short, the last paragraph of Section 30 provides that if a tax exempt charitable institution
conducts "any" activity for profit, such activity is not tax exempt even as its not-for-profit
activities remain tax exempt. This paragraph qualifies the requirements in Section 30(E) that the
"[n]on-stock corporation or association [must be] organized and operated exclusively for x x x
charitable x x x purposes x x x." It likewise qualifies the requirement in Section 30(G) that the
civic organization must be "operated exclusively" for the promotion of social welfare.

Thus, even if the charitable institution must be "organized and operated exclusively" for
charitable purposes, it is nevertheless allowed to engage in "activities conducted for profit"
without losing its tax exempt status for its not-for-profit activities. The only consequence is that
the "income of whatever kind and character" of a charitable institution "from any of its activities
conducted for profit, regardless of the disposition made of such income, shall be subject to tax."
Prior to the introduction of Section 27(B), the tax rate on such income from for-profit activities
was the ordinary corporate rate under Section 27(A). With the introduction of Section 27(B), the
tax rate is now 10%.

In 1998, St. Luke's had total revenues of ₱1,730,367,965 from services to paying patients. It
cannot be disputed that a hospital which receives approximately ₱1.73 billion from paying
patients is not an institution "operated exclusively" for charitable purposes. Clearly, revenues
from paying patients are income received from "activities conducted for profit." 52 Indeed, St.
Luke's admits that it derived profits from its paying patients. St. Luke's declared ₱1,730,367,965
as "Revenues from Services to Patients" in contrast to its "Free Services" expenditure of
₱218,187,498. In its Comment in G.R. No. 195909, St. Luke's showed the following
"calculation" to support its claim that 65.20% of its "income after expenses was allocated to free
or charitable services" in 1998. 53
 REVENUES FROM SERVICES TO PATIENTS ₱1,730,367,965.00

OPERATING EXPENSES
Professional care of patients ₱1,016,608,394.00
Administrative 287,319,334.00
Household and Property 91,797,622.00
₱1,395,725,350.00

INCOME FROM OPERATIONS ₱334,642,615.00 100%

Free Services -218,187,498.00 -65.20%
INCOME FROM OPERATIONS, Net of FREE SERVICES ₱116,455,117.00 34.80%

OTHER INCOME 17,482,304.00

EXCESS OF REVENUES OVER EXPENSES ₱133,937,421.00

In Lung Center, this Court declared:

"[e]xclusive" is defined as possessed and enjoyed to the exclusion of others; debarred from
participation or enjoyment; and "exclusively" is defined, "in a manner to exclude; as enjoying a
privilege exclusively." x x x The words "dominant use" or "principal use" cannot be substituted
for the words "used exclusively" without doing violence to the Constitution and the law. Solely is
synonymous with exclusively. 54

The Court cannot expand the meaning of the words "operated exclusively" without violating the
NIRC. Services to paying patients are activities conducted for profit. They cannot be considered
any other way. There is a "purpose to make profit over and above the cost" of services. 55 The
₱1.73 billion total revenues from paying patients is not even incidental to St. Luke's charity
expenditure of ₱218,187,498 for non-paying patients.

St. Luke's claims that its charity expenditure of ₱218,187,498 is 65.20% of its operating income
in 1998. However, if a part of the remaining 34.80% of the operating income is reinvested in
property, equipment or facilities used for services to paying and non-paying patients, then it
cannot be said that the income is "devoted or used altogether to the charitable object which it is
intended to achieve." 56 The income is plowed back to the corporation not entirely for charitable
purposes, but for profit as well. In any case, the last paragraph of Section 30 of the NIRC
expressly qualifies that income from activities for profit is taxable "regardless of the disposition
made of such income."

Jesus Sacred Heart College declared that there is no official legislative record explaining the
phrase "any activity conducted for profit." However, it quoted a deposition of Senator Mariano
Jesus Cuenco, who was a member of the Committee of Conference for the Senate, which
introduced the phrase "or from any activity conducted for profit."

P. Cuando ha hablado de la Universidad de Santo Tomás que tiene un hospital, no cree Vd. que
es una actividad esencial dicho hospital para el funcionamiento del colegio de medicina de dicha
universidad?

xxxx

R. Si el hospital se limita a recibir enformos pobres, mi contestación seria afirmativa; pero

considerando que el hospital tiene cuartos de pago, y a los mismos generalmente van enfermos
de buena posición social económica, lo que se paga por estos enfermos debe estar sujeto a
'income tax', y es una de las razones que hemos tenido para insertar las palabras o frase 'or from
any activity conducted for profit.' 57

The question was whether having a hospital is essential to an educational institution like the
College of Medicine of the University of Santo Tomas. Senator Cuenco answered that if the
hospital has paid rooms generally occupied by people of good economic standing, then it should
be subject to income tax. He said that this was one of the reasons Congress inserted the phrase
"or any activity conducted for profit."

The question in Jesus Sacred Heart College involves an educational institution. 58 However, it is
applicable to charitable institutions because Senator Cuenco's response shows an intent to focus
on the activities of charitable institutions. Activities for profit should not escape the reach of
taxation. Being a non-stock and non-profit corporation does not, by this reason alone, completely
exempt an institution from tax. An institution cannot use its corporate form to prevent its
profitable activities from being taxed.

The Court finds that St. Luke's is a corporation that is not "operated exclusively" for charitable or
social welfare purposes insofar as its revenues from paying patients are concerned. This ruling is
based not only on a strict interpretation of a provision granting tax exemption, but also on the
clear and plain text of Section 30(E) and (G). Section 30(E) and (G) of the NIRC requires that an
institution be "operated exclusively" for charitable or social welfare purposes to be completely
exempt from income tax. An institution under Section 30(E) or (G) does not lose its tax
exemption if it earns income from its for-profit activities. Such income from for-profit activities,
under the last paragraph of Section 30, is merely subject to income tax, previously at the ordinary
corporate rate but now at the preferential 10% rate pursuant to Section 27(B).

A tax exemption is effectively a social subsidy granted by the State because an exempt institution
is spared from sharing in the expenses of government and yet benefits from them. Tax
exemptions for charitable institutions should therefore be limited to institutions beneficial to the
public and those which improve social welfare. A profit-making entity should not be allowed to
exploit this subsidy to the detriment of the government and other taxpayers.1âwphi1

St. Luke's fails to meet the requirements under Section 30(E) and (G) of the NIRC to be
completely tax exempt from all its income. However, it remains a proprietary non-profit hospital
under Section 27(B) of the NIRC as long as it does not distribute any of its profits to its members
and such profits are reinvested pursuant to its corporate purposes. St. Luke's, as a proprietary
non-profit hospital, is entitled to the preferential tax rate of 10% on its net income from its for-
profit activities.

St. Luke's is therefore liable for deficiency income tax in 1998 under Section 27(B) of the NIRC.
However, St. Luke's has good reasons to rely on the letter dated 6 June 1990 by the BIR, which
opined that St. Luke's is "a corporation for purely charitable and social welfare purposes"59 and
thus exempt from income tax. 60 In Michael J. Lhuillier, Inc. v. Commissioner of Internal
Revenue, 61 the Court said that "good faith and honest belief that one is not subject to tax on the
basis of previous interpretation of government agencies tasked to implement the tax law, are
sufficient justification to delete the imposition of surcharges and interest." 62

WHEREFORE, the petition of the Commissioner of Internal Revenue in G.R. No. 195909 is
PARTLY GRANTED. The Decision of the Court of Tax Appeals En Banc dated 19 November
2010 and its Resolution dated 1 March 2011 in CTA Case No. 6746 are MODIFIED. St. Luke's
Medical Center, Inc. is ORDERED TO PAY the deficiency income tax in 1998 based on the 10%
preferential income tax rate under Section 27(B) of the National Internal Revenue Code.
However, it is not liable for surcharges and interest on such deficiency income tax under Sections
248 and 249 of the National Internal Revenue Code. All other parts of the Decision and
Resolution of the Court of Tax Appeals are AFFIRMED.

The petition of St. Luke's Medical Center, Inc. in G.R. No. 195960 is DENIED for violating
Section 1, Rule 45 of the Rules of Court.

SO ORDERED.
G.R. No. 196596

COMMISSIONER OF INTERNAL REVENUE, Petitioner

vs.
DE LA SALLE UNIVERSITY, INC., Respondent

x-----------------------x

G.R. No. 198841

DE LA SALLE UNIVERSITY INC., Petitioner,

vs.
COMMISSIONER OF INTERNAL REVENUE, Respondent.

x-----------------------x

G.R. No. 198941

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

vs.
DE LA SALLE UNIVERSITY, INC., Respondent.

DECISION

BRION, J.:

Before the Court are consolidated petitions for review on certiorari:1

1. G.R. No. 196596 filed by the Commissioner of Internal Revenue (Commissioner) to assail the
December 10, 2010 decision and March 29, 2011 resolution of the Court of Tax Appeals (CTA)
in En Banc Case No. 622;2

2. G.R. No. 198841 filed by De La Salle University, Inc. (DLSU) to assail the June 8, 2011
decision and October 4, 2011 resolution in CTA En Banc Case No. 671;3 and

3. G.R. No. 198941 filed by the Commissioner to assail the June 8, 2011 decision and October 4,
2011 resolution in CTA En Banc Case No. 671.4

G.R. Nos. 196596, 198841 and 198941 all originated from CTA Special First Division (CTA
Division) Case No. 7303. G.R. No. 196596 stemmed from CTA En Banc Case No. 622 filed by
the Commissioner to challenge CTA Case No. 7303. G.R. No. 198841 and 198941 both stemmed
from CTA En Banc Case No. 671 filed by DLSU to also challenge CTA Case No. 7303.

The Factual Antecedents

Sometime in 2004, the Bureau of Internal Revenue (BIR) issued to DLSU Letter of Authority
(LOA) No. 2794 authorizing its revenue officers to examine the latter's books of accounts and
other accounting records for all internal revenue taxes for the period Fiscal Year Ending 2003
and Unverified Prior Years.5

On May 19, 2004, BIR issued a Preliminary Assessment Notice to DLSU.6

Subsequently on August 18, 2004, the BIR through a Formal Letter of Demand assessed DLSU
the following deficiency taxes: (1) income tax on rental earnings from restaurants/canteens and
bookstores operating within the campus; (2) value-added tax (VAI) on business income; and (3)
documentary stamp tax (DSI) on loans and lease contracts. The BIR demanded the payment of
₱17,303,001.12, inclusive of surcharge, interest and penalty for taxable years 2001, 2002 and
2003.7

DLSU protested the assessment. The Commissioner failed to act on the protest; thus, DLSU filed
on August 3, 2005 a petition for review with the CTA Division.8

DLSU, a non-stock, non-profit educational institution, principally anchored its petition on

Article XIV, Section 4 (3) of the Constitution, which reads:

(3) All revenues and assets of non-stock, non-profit educational institutions used actually,
directly, and exclusively for educational purposes shall be exempt from taxes and duties. xxx.

On January 5, 2010, the CTA Division partially granted DLSU's petition for review. The
dispositive portion of the decision reads:

WHEREFORE, the Petition for Review is PARTIALLY GRANTED. The DST assessment on
the loan transactions of [DLSU] in the amount of ₱1,1681,774.00 is hereby CANCELLED.
However, [DLSU] is ORDERED TO PAY deficiency income tax, VAT and DST on its lease
contracts, plus 25% surcharge for the fiscal years 2001, 2002 and 2003 in the total amount of
₱18,421,363.53 ... xxx.

In addition, [DLSU] is hereby held liable to pay 20% delinquency interest on the total amount
due computed from September 30, 2004 until full payment thereof pursuant to Section 249(C)(3)
of the [National Internal Revenue Code]. Further, the compromise penalties imposed by [the
Commissioner] were excluded, there being no compromise agreement between the parties.

SO ORDERED.9

Both the Commissioner and DLSU moved for the reconsideration of the January 5, 2010
decision.10 On April 6, 2010, the CTA Division denied the Commissioner's motion for
reconsideration while it held in abeyance the resolution on DLSU's motion for reconsideration.11

On May 13, 2010, the Commissioner appealed to the CTA En Banc (CTA En Banc Case No.
622) arguing that DLSU's use of its revenues and assets for non-educational or commercial
purposes removed these items from the exemption coverage under the Constitution.12
On May 18, 2010, DLSU formally offered to the CTA Division supplemental pieces of
documentary evidence to prove that its rental income was used actually, directly and exclusively
for educational purposes.13 The Commissioner did not promptly object to the formal offer of
supplemental evidence despite notice.14

On July 29, 2010, the CTA Division, in view of the supplemental evidence submitted, reduced
the amount of DLSU's tax deficiencies. The dispositive portion of the amended decision reads:

WHEREFORE, [DLSU]'s Motion for Partial Reconsideration is hereby PARTIALLY

GRANTED. [DLSU] is hereby ORDERED TO PAY for deficiency income tax, VAT and DST
plus 25% surcharge for the fiscal years 2001, 2002 and 2003 in the total adjusted amount of
₱5,506,456.71 ... xxx.

In addition, [DLSU] is hereby held liable to pay 20% per annum deficiency interest on the ...
basic deficiency taxes ... until full payment thereof pursuant to Section 249(B) of the [National
Internal Revenue Code] ... xxx.

Further, [DLSU] is hereby held liable to pay 20% per annum delinquency interest on the
deficiency taxes, surcharge and deficiency interest which have accrued ... from September 30,
2004 until fully paid.15

Consequently, the Commissioner supplemented its petition with the CTA En Banc and argued
that the CTA Division erred in admitting DLSU's additional evidence.16

Dissatisfied with the partial reduction of its tax liabilities, DLSU filed a separate petition for
review with the CTA En Banc (CTA En Banc Case No. 671) on the following grounds: (1) the
entire assessment should have been cancelled because it was based on an invalid LOA; (2)
assuming the LOA was valid, the CTA Division should still have cancelled the entire assessment
because DLSU submitted evidence similar to those submitted by Ateneo De Manila University
(Ateneo) in a separate case where the CTA cancelled Ateneo's tax assessment;17 and (3) the CTA
Division erred in finding that a portion of DLSU's rental income was not proved to have been
used actually, directly and exclusively for educational purposes.18

The CTA En Banc Rulings

CTA En Banc Case No. 622

The CTA En Banc dismissed the Commissioner's petition for review and sustained the findings
of the CTA Division.19

Tax on rental income

Relying on the findings of the court-commissioned Independent Certified Public Accountant

(Independent CPA), the CTA En Banc found that DLSU was able to prove that a portion of the
assessed rental income was used actually, directly and exclusively for educational purposes;
hence, exempt from tax.20 The CTA En Banc was satisfied with DLSU's supporting evidence
confirming that part of its rental income had indeed been used to pay the loan it obtained to build
the university's Physical Education – Sports Complex.21

Parenthetically, DLSU's unsubstantiated claim for exemption, i.e., the part of its income that was
not shown by supporting documents to have been actually, directly and exclusively used for
educational purposes, must be subjected to income tax and VAT.22

DST on loan and mortgage transactions

Contrary to the Commissioner's contention, DLSU froved its remittance of the DST due on its
loan and mortgage documents.23 The CTA En Banc found that DLSU's DST payments had been
remitted to the BIR, evidenced by the stamp on the documents made by a DST imprinting
machine, which is allowed under Section 200 (D) of the National Internal Revenue Code (Tax
Code)24 and Section 2 of Revenue Regulations (RR) No. 15-2001.25

Admissibility of DLSU's supplemental evidence

The CTA En Banc held that the supplemental pieces of documentary evidence were admissible
even if DLSU formally offered them only when it moved for reconsideration of the CTA
Division's original decision. Notably, the law creating the CTA provides that proceedings before
it shall not be governed strictly by the technical rules of evidence.26

The Commissioner moved but failed to obtain a reconsideration of the CTA En Banc's December
10, 2010 decision.27 Thus, she came to this court for relief through a petition for review on
certiorari (G.R. No. 196596).

CTA En Banc Case No. 671

The CTA En Banc partially granted DLSU's petition for review and further reduced its tax
liabilities to ₱2,554,825.47 inclusive of surcharge.28

On the validity of the Letter of Authority

The issue of the LOA' s validity was raised during trial;29 hence, the issue was deemed properly
submitted for decision and reviewable on appeal.

Citing jurisprudence, the CTA En Banc held that a LOA should cover only one taxable period
and that the practice of issuing a LOA covering audit of unverified prior years is prohibited.30
The prohibition is consistent with Revenue Memorandum Order (RMO) No. 43-90, which
provides that if the audit includes more than one taxable period, the other periods or years shall
be specifically indicated in the LOA.31

In the present case, the LOA issued to DLSU is for Fiscal Year Ending 2003 and Unverified
Prior Years. Hence, the assessments for deficiency income tax, VAT and DST for taxable years
2001 and 2002 are void, but the assessment for taxable year 2003 is valid.32
On the applicability of the Ateneo case

The CTA En Banc held that the Ateneo case is not a valid precedent because it involved different
parties, factual settings, bases of assessments, sets of evidence, and defenses.33

On the CTA Division's appreciation of the evidence

The CTA En Banc affirmed the CTA Division's appreciation of DLSU' s evidence. It held that
while DLSU successfully proved that a portion of its rental income was transmitted and used to
pay the loan obtained to fund the construction of the Sports Complex, the rental income from
other sources were not shown to have been actually, directly and exclusively used for
educational purposes.34

Not pleased with the CTA En Banc's ruling, both DLSU (G.R. No. 198841) and the
Commissioner (G.R. No. 198941) came to this Court for relief.

The Consolidated Petitions

G.R. No. 196596

The Commissioner submits the following arguments:

First, DLSU's rental income is taxable regardless of how such income is derived, used or
disposed of.35 DLSU's operations of canteens and bookstores within its campus even though
exclusively serving the university community do not negate income tax liability.36

The Commissioner contends that Article XIV, Section 4 (3) of the Constitution must be
harmonized with Section 30 (H) of the Tax Code, which states among others, that the income of
whatever kind and character of [a non-stock and non-profit educational institution] from any of
[its] properties, real or personal, or from any of [its] activities conducted for profit regardless of
the disposition made of such income, shall be subject to tax imposed by this Code.37

The Commissioner argues that the CTA En Banc misread and misapplied the case of
Commissioner of Internal Revenue v. YMCA38 to support its conclusion that revenues however
generated are covered by the constitutional exemption, provided that, the revenues will be used
for educational purposes or will be held in reserve for such purposes.39

On the contrary, the Commissioner posits that a tax-exempt organization like DLSU is exempt
only from property tax but not from income tax on the rentals earned from property.40 Thus,
DLSU's income from the leases of its real properties is not exempt from taxation even if the
income would be used for educational purposes.41

Second, the Commissioner insists that DLSU did not prove the fact of DST payment42 and that
it is not qualified to use the On-Line Electronic DST Imprinting Machine, which is available only
to certain classes of taxpayers under RR No. 9-2000.43
Finally, the Commissioner objects to the admission of DLSU's supplemental offer of evidence.
The belated submission of supplemental evidence reopened the case for trial, and worse, DLSU
offered the supplemental evidence only after it received the unfavorable CTA Division's original
decision.44 In any case, DLSU's submission of supplemental documentary evidence was
unnecessary since its rental income was taxable regardless of its disposition.45

G.R. No. 198841

DLSU argues as that:

First, RMO No. 43-90 prohibits the practice of issuing a LOA with any indication of unverified
prior years. A LOA issued contrary to RMO No. 43-90 is void, thus, an assessment issued based
on such defective LOA must also be void.46

DLSU points out that the LOA issued to it covered the Fiscal Year Ending 2003 and Unverified
Prior Years. On the basis of this defective LOA, the Commissioner assessed DLSU for
deficiency income tax, VAT and DST for taxable years 2001, 2002 and 2003.47 DLSU objects to
the CTA En Banc's conclusion that the LOA is valid for taxable year 2003. According to DLSU,
when RMO No. 43-90 provides that:

The practice of issuing [LOAs] covering audit of 'unverified prior years' is hereby prohibited.

it refers to the LOA which has the format "Base Year + Unverified Prior Years." Since the LOA
issued to DLSU follows this format, then any assessment arising from it must be entirely
voided.48

Second, DLSU invokes the principle of uniformity in taxation, which mandates that for similarly
situated parties, the same set of evidence should be appreciated and weighed in the same
manner.49 The CTA En Banc erred when it did not similarly appreciate DLSU' s evidence as it
did to the pieces of evidence submitted by Ateneo, also a non-stock, non-profit educational
institution.50

G.R. No. 198941

The issues and arguments raised by the Commissioner in G.R. No. 198941 petition are exactly
the same as those she raised in her: (1) petition docketed as G.R. No. 196596 and (2) comment
on DLSU's petition docketed as G.R. No. 198841.51

Counter-arguments

DLSU's Comment on G.R. No. 196596

First, DLSU questions the defective verification attached to the petition.52

Second, DLSU stresses that Article XIV, Section 4 (3) of the Constitution is clear that all assets
and revenues of non-stock, non-profit educational institutions used actually, directly and
exclusively for educational purposes are exempt from taxes and duties.53

On this point, DLSU explains that: (1) the tax exemption of non-stock, non-profit educational
institutions is novel to the 1987 Constitution and that Section 30 (H) of the 1997 Tax Code
cannot amend the 1987 Constitution;54 (2) Section 30 of the 1997 Tax Code is almost an exact
replica of Section 26 of the 1977 Tax Code -with the addition of non-stock, non-profit
educational institutions to the list of tax-exempt entities; and (3) that the 1977 Tax Code was
promulgated when the 1973 Constitution was still in place.

DLSU elaborates that the tax exemption granted to a private educational institution under the
1973 Constitution was only for real property tax. Back then, the special tax treatment on income
of private educational institutions only emanates from statute, i.e., the 1977 Tax Code. Only
under the 1987 Constitution that exemption from tax of all the assets and revenues of non-stock,
non-profit educational institutions used actually, directly and exclusively for educational
purposes, was expressly and categorically enshrined.55

DLSU thus invokes the doctrine of constitutional supremacy, which renders any subsequent law
that is contrary to the Constitution void and without any force and effect.56 Section 30 (H) of the
1997 Tax Code insofar as it subjects to tax the income of whatever kind and character of a non-
stock and non-profit educational institution from any of its properties, real or personal, or from
any of its activities conducted for profit regardless of the disposition made of such income,
should be declared without force and effect in view of the constitutionally granted tax exemption
on "all revenues and assets of non-stock, non-profit educational institutions used actually,
directly, and exclusively for educational purposes."57

DLSU further submits that it complies with the requirements enunciated in the YMCA case, that
for an exemption to be granted under Article XIV, Section 4 (3) of the Constitution, the taxpayer
must prove that: (1) it falls under the classification non-stock, non-profit educational institution;
and (2) the income it seeks to be exempted from taxation is used actually, directly and
exclusively for educational purposes.58 Unlike YMCA, which is not an educational institution,
DLSU is undisputedly a non-stock, non-profit educational institution. It had also submitted
evidence to prove that it actually, directly and exclusively used its income for educational
purposes.59

DLSU also cites the deliberations of the 1986 Constitutional Commission where they recognized
that the tax exemption was granted "to incentivize private educational institutions to share with
the State the responsibility of educating the youth."60

Third, DLSU highlights that both the CTA En Banc and Division found that the bank that
handled DLSU' s loan and mortgage transactions had remitted to the BIR the DST through an
imprinting machine, a method allowed under RR No. 15-2001.61 In any case, DLSU argues that
it cannot be held liable for DST owing to the exemption granted under the Constitution.62
Finally, DLSU underscores that the Commissioner, despite notice, did not oppose the formal
offer of supplemental evidence. Because of the Commissioner's failure to timely object, she
became bound by the results of the submission of such supplemental evidence.63

The CIR's Comment on G.R. No. 198841

The Commissioner submits that DLSU is estopped from questioning the LOA's validity because
it failed to raise this issue in both the administrative and judicial proceedings.64 That it was
asked on cross-examination during the trial does not make it an issue that the CTA could
resolve.65 The Commissioner also maintains that DLSU's rental income is not tax-exempt
because an educational institution is only exempt from property tax but not from tax on the
income earned from the property.66

DLSU's Comment on G.R. No. 198941

DLSU puts forward the same counter-arguments discussed above.67 In addition, DLSU prays
that the Court award attorney's fees in its favor because it was constrained to unnecessarily retain
the services of counsel in this separate petition.68

Issues

Although the parties raised a number of issues, the Court shall decide only the pivotal issues,
which we summarize as follows:

I. Whether DLSU' s income and revenues proved to have been used actually, directly and
exclusively for educational purposes are exempt from duties and taxes;

II. Whether the entire assessment should be voided because of the defective LOA;

III. Whether the CTA correctly admitted DLSU's supplemental pieces of evidence; and

IV. Whether the CTA's appreciation of the sufficiency of DLSU's evidence may be
disturbed by the Court.

Our Ruling

As we explain in full below, we rule that:

I. The income, revenues and assets of non-stock, non-profit educational institutions

proved to have been used actually, directly and exclusively for educational purposes are
exempt from duties and taxes.

II. The LOA issued to DLSU is not entirely void. The assessment for taxable year 2003 is
valid.

III. The CTA correctly admitted DLSU's formal offer of supplemental evidence; and
 IV. The CTA's appreciation of evidence is conclusive unless the CTA is shown to have
manifestly overlooked certain relevant facts not disputed by the parties and which, if
properly considered, would justify a different conclusion.

The parties failed to convince the Court that the CTA overlooked or failed to consider relevant
facts. We thus sustain the CTA En Banc's findings that:

a. DLSU proved that a portion of its rental income was used actually, directly and
exclusively for educational purposes; and

b. DLSU proved the payment of the DST through its bank's on-line imprinting machine.

I. The revenues and assets of non-stock,

non-profit educational institutions
proved to have been used actually,
directly, and exclusively for educational
purposes are exempt from duties and
taxes.

DLSU rests it case on Article XIV, Section 4 (3) of the 1987 Constitution, which reads:

(3) All revenues and assets of non-stock, non-profit educational institutions used actually,
directly, and exclusively for educational purposes shall be exempt from taxes and duties.
Upon the dissolution or cessation of the corporate existence of such institutions, their assets shall
be disposed of in the manner provided by law.

Proprietary educational institutions, including those cooperatively owned, may likewise be

entitled to such exemptions subject to the limitations provided by law including restrictions
on dividends and provisions for reinvestment. [underscoring and emphasis supplied]

Before fully discussing the merits of the case, we observe that:

First, the constitutional provision refers to two kinds of educational institutions: (1) non-stock,
non-profit educational institutions and (2) proprietary educational institutions.69

Second, DLSU falls under the first category. Even the Commissioner admits the status of DLSU
as a non-stock, non-profit educational institution.70

Third, while DLSU's claim for tax exemption arises from and is based on the Constitution, the
Constitution, in the same provision, also imposes certain conditions to avail of the exemption.
We discuss below the import of the constitutional text vis-a-vis the Commissioner's counter-
arguments.

Fourth, there is a marked distinction between the treatment of non-stock, non-profit educational
institutions and proprietary educational institutions. The tax exemption granted to non-stock,
non-profit educational institutions is conditioned only on the actual, direct and exclusive use of
their revenues and assets for educational purposes. While tax exemptions may also be granted to
proprietary educational institutions, these exemptions may be subject to limitations imposed by
Congress.

As we explain below, the marked distinction between a non-stock, non-profit and a proprietary
educational institution is crucial in determining the nature and extent of the tax exemption
granted to non-stock, non-profit educational institutions.

The Commissioner opposes DLSU's claim for tax exemption on the basis of Section 30 (H) of
the Tax Code. The relevant text reads:

The following organizations shall not be taxed under this Title [Tax on

Income] in respect to income received by them as such:

xxxx

(H) A non-stock and non-profit educational institution

xxxx

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and
character of the foregoing organizations from any of their properties, real or personal, or
from any of their activities conducted for profit regardless of the disposition made of such
income shall be subject to tax imposed under this Code. [underscoring and emphasis
supplied]

The Commissioner posits that the 1997 Tax Code qualified the tax exemption granted to non-
stock, non-profit educational institutions such that the revenues and income they derived from
their assets, or from any of their activities conducted for profit, are taxable even if these revenues
and income are used for educational purposes.

Did the 1997 Tax Code qualify the tax exemption constitutionally-granted to non-stock, non-
profit educational institutions?

We answer in the negative.

While the present petition appears to be a case of first impression,71 the Court in the YMCA case
had in fact already analyzed and explained the meaning of Article XIV, Section 4 (3) of the
Constitution. The Court in that case made doctrinal pronouncements that are relevant to the
present case.

The issue in YMCA was whether the income derived from rentals of real property owned by the
YMCA, established as a "welfare, educational and charitable non-profit corporation," was
subject to income tax under the Tax Code and the Constitution.72
The Court denied YMCA's claim for exemption on the ground that as a charitable institution
falling under Article VI, Section 28 (3) of the Constitution,73 the YMCA is not tax-exempt per
se; " what is exempted is not the institution itself... those exempted from real estate taxes are
lands, buildings and improvements actually, directly and exclusively used for religious,
charitable or educational purposes."74

The Court held that the exemption claimed by the YMCA is expressly disallowed by the last
paragraph of then Section 27 (now Section 30) of the Tax Code, which mandates that the income
of exempt organizations from any of their properties, real or personal, are subject to the same tax
imposed by the Tax Code, regardless of how that income is used. The Court ruled that the last
paragraph of Section 27 unequivocally subjects to tax the rent income of the YMCA from its
property.75

In short, the YMCA is exempt only from property tax but not from income tax.

As a last ditch effort to avoid paying the taxes on its rental income, the YMCA invoked the tax
privilege granted under Article XIV, Section 4 (3) of the Constitution.

The Court denied YMCA's claim that it falls under Article XIV, Section 4 (3) of the Constitution
holding that the term educational institution, when used in laws granting tax exemptions, refers
to the school system (synonymous with formal education); it includes a college or an educational
establishment; it refers to the hierarchically structured and chronologically graded learnings
organized and provided by the formal school system.76

The Court then significantly laid down the requisites for availing the tax exemption under Article
XIV, Section 4 (3), namely: (1) the taxpayer falls under the classification non-stock, non-profit
educational institution; and (2) the income it seeks to be exempted from taxation is used
actually, directly and exclusively for educational purposes.77

We now adopt YMCA as precedent and hold that:

1. The last paragraph of Section 30 of the Tax Code is without force and effect with respect to
non-stock, non-profit educational institutions, provided, that the non-stock, non-profit
educational institutions prove that its assets and revenues are used actually, directly and
exclusively for educational purposes.

2. The tax-exemption constitutionally-granted to non-stock, non-profit educational institutions, is

not subject to limitations imposed by law.

The tax exemption granted by the

Constitution to non-stock, non-profit
educational institutions is conditioned only
on the actual, direct and exclusive use of
their assets, revenues and income78 for
educational purposes.
We find that unlike Article VI, Section 28 (3) of the Constitution (pertaining to charitable
institutions, churches, parsonages or convents, mosques, and non-profit cemeteries), which
exempts from tax only the assets, i.e., "all lands, buildings, and improvements, actually,
directly, and exclusively used for religious, charitable, or educational purposes ... ," Article XIV,
Section 4 (3) categorically states that "[a]ll revenues and assets ... used actually, directly, and
exclusively for educational purposes shall be exempt from taxes and duties."

The addition and express use of the word revenues in Article XIV, Section 4 (3) of the
Constitution is not without significance.

We find that the text demonstrates the policy of the 1987 Constitution, discernible from the
records of the 1986 Constitutional Commission79 to provide broader tax privilege to non-stock,
non-profit educational institutions as recognition of their role in assisting the State provide a
public good. The tax exemption was seen as beneficial to students who may otherwise be
charged unreasonable tuition fees if not for the tax exemption extended to all revenues and
assets of non-stock, non-profit educational institutions.80

Further, a plain reading of the Constitution would show that Article XIV, Section 4 (3) does not
require that the revenues and income must have also been sourced from educational activities or
activities related to the purposes of an educational institution. The phrase all revenues is
unqualified by any reference to the source of revenues. Thus, so long as the revenues and income
are used actually, directly and exclusively for educational purposes, then said revenues and
income shall be exempt from taxes and duties.81

We find it helpful to discuss at this point the taxation of revenues versus the taxation of assets.

Revenues consist of the amounts earned by a person or entity from the conduct of business
operations.82 It may refer to the sale of goods, rendition of services, or the return of an
investment. Revenue is a component of the tax base in income tax,83 VAT,84 and local business
tax (LBT).85

Assets, on the other hand, are the tangible and intangible properties owned by a person or
entity.86 It may refer to real estate, cash deposit in a bank, investment in the stocks of a
corporation, inventory of goods, or any property from which the person or entity may derive
income or use to generate the same. In Philippine taxation, the fair market value of real property
is a component of the tax base in real property tax (RPT).87 Also, the landed cost of imported
goods is a component of the tax base in VAT on importation88 and tariff duties.89

Thus, when a non-stock, non-profit educational institution proves that it uses its revenues
actually, directly, and exclusively for educational purposes, it shall be exempted from income
tax, VAT, and LBT. On the other hand, when it also shows that it uses its assets in the form of
real property for educational purposes, it shall be exempted from RPT.

To be clear, proving the actual use of the taxable item will result in an exemption, but the specific
tax from which the entity shall be exempted from shall depend on whether the item is an item of
revenue or asset.
To illustrate, if a university leases a portion of its school building to a bookstore or cafeteria, the
leased portion is not actually, directly and exclusively used for educational purposes, even if the
bookstore or canteen caters only to university students, faculty and staff.

The leased portion of the building may be subject to real property tax, as held in Abra Valley
College, Inc. v. Aquino.90 We ruled in that case that the test of exemption from taxation is the
use of the property for purposes mentioned in the Constitution. We also held that the exemption
extends to facilities which are incidental to and reasonably necessary for the accomplishment of
the main purposes.

In concrete terms, the lease of a portion of a school building for commercial purposes, removes
such asset from the property tax exemption granted under the Constitution.91 There is no
exemption because the asset is not used actually, directly and exclusively for educational
purposes. The commercial use of the property is also not incidental to and reasonably necessary
for the accomplishment of the main purpose of a university, which is to educate its students.

However, if the university actually, directly and exclusively uses for educational purposes the
revenues earned from the lease of its school building, such revenues shall be exempt from taxes
and duties. The tax exemption no longer hinges on the use of the asset from which the revenues
were earned, but on the actual, direct and exclusive use of the revenues for educational
purposes.

Parenthetically, income and revenues of non-stock, non-profit educational institution not used
actually, directly and exclusively for educational purposes are not exempt from duties and taxes.
To avail of the exemption, the taxpayer must factually prove that it used actually, directly and
exclusively for educational purposes the revenues or income sought to be exempted.

The crucial point of inquiry then is on the use of the assets or on the use of the revenues. These
are two things that must be viewed and treated separately. But so long as the assets or revenues
are used actually, directly and exclusively for educational purposes, they are exempt from duties
and taxes.

The tax exemption granted by the

Constitution to non-stock, non-profit
educational institutions, unlike the exemption
that may be availed of by proprietary
educational institutions, is not subject to
limitations imposed by law.

That the Constitution treats non-stock, non-profit educational institutions differently from
proprietary educational institutions cannot be doubted. As discussed, the privilege granted to the
former is conditioned only on the actual, direct and exclusive use of their revenues and assets for
educational purposes. In clear contrast, the tax privilege granted to the latter may be subject to
limitations imposed by law.
We spell out below the difference in treatment if only to highlight the privileged status of non-
stock, non-profit educational institutions compared with their proprietary counterparts.

While a non-stock, non-profit educational institution is classified as a tax-exempt entity under

Section 30 (Exemptions from Tax on Corporations) of the Tax Code, a proprietary educational
institution is covered by Section 27 (Rates of Income Tax on Domestic Corporations).

To be specific, Section 30 provides that exempt organizations like non-stock, non-profit

educational institutions shall not be taxed on income received by them as such.

Section 27 (B), on the other hand, states that "[p]roprietary educational institutions ... which are
nonprofit shall pay a tax of ten percent (10%) on their taxable income .. . Provided, that if the
gross income from unrelated trade, business or other activity exceeds fifty percent (50%) of the
total gross income derived by such educational institutions ... [the regular corporate income tax
of 30%] shall be imposed on the entire taxable income ... "92

By the Tax Code's clear terms, a proprietary educational institution is entitled only to the reduced
rate of 10% corporate income tax. The reduced rate is applicable only if: (1) the proprietary
educational institution is nonprofit and (2) its gross income from unrelated trade, business or
activity does not exceed 50% of its total gross income.

Consistent with Article XIV, Section 4 (3) of the Constitution, these limitations do not apply to
non-stock, non-profit educational institutions.

Thus, we declare the last paragraph of Section 30 of the Tax Code without force and effect for
being contrary to the Constitution insofar as it subjects to tax the income and revenues of non-
stock, non-profit educational institutions used actually, directly and exclusively for educational
purpose. We make this declaration in the exercise of and consistent with our duty93 to uphold the
primacy of the Constitution.94

Finally, we stress that our holding here pertains only to non-stock, non-profit educational
institutions and does not cover the other exempt organizations under Section 30 of the Tax Code.

For all these reasons, we hold that the income and revenues of DLSU proven to have been used
actually, directly and exclusively for educational purposes are exempt from duties and taxes.

II. The LOA issued to DLSU is

not entirely void. The
assessment for taxable year
2003 is valid.

DLSU objects to the CTA En Banc 's conclusion that the LOA is valid for taxable year 2003 and
insists that the entire LOA should be voided for being contrary to RMO No. 43-90, which
provides that if tax audit includes more than one taxable period, the other periods or years shall
be specifically indicated in the LOA.
A LOA is the authority given to the appropriate revenue officer to examine the books of account
and other accounting records of the taxpayer in order to determine the taxpayer's correct internal
revenue liabilities95 and for the purpose of collecting the correct amount of tax,96 in accordance
with Section 5 of the Tax Code, which gives the CIR the power to obtain information, to
summon/examine, and take testimony of persons. The LOA commences the audit process97 and
informs the taxpayer that it is under audit for possible deficiency tax assessment.

Given the purposes of a LOA, is there basis to completely nullify the LOA issued to DLSU, and
consequently, disregard the BIR and the CTA's findings of tax deficiency for taxable year 2003?

We answer in the negative.

The relevant provision is Section C of RMO No. 43-90, the pertinent portion of which reads:

3. A Letter of Authority [LOA] should cover a taxable period not exceeding one taxable year.
The practice of issuing [LO As] covering audit of unverified prior years is hereby prohibited. If
the audit of a taxpayer shall include more than one taxable period, the other periods or years shall
be specifically indicated in the [LOA].98

What this provision clearly prohibits is the practice of issuing LOAs covering audit of unverified
prior years. RMO 43-90 does not say that a LOA which contains unverified prior years is void. It
merely prescribes that if the audit includes more than one taxable period, the other periods or
years must be specified. The provision read as a whole requires that if a taxpayer is audited for
more than one taxable year, the BIR must specify each taxable year or taxable period on separate
LOAs.

Read in this light, the requirement to specify the taxable period covered by the LOA is simply to
inform the taxpayer of the extent of the audit and the scope of the revenue officer's authority.
Without this rule, a revenue officer can unduly burden the taxpayer by demanding random
accounting records from random unverified years, which may include documents from as far
back as ten years in cases of fraud audit.99

In the present case, the LOA issued to DLSU is for Fiscal Year Ending 2003 and Unverified
Prior Years. The LOA does not strictly comply with RMO 43-90 because it includes unverified
prior years. This does not mean, however, that the entire LOA is void.

As the CTA correctly held, the assessment for taxable year 2003 is valid because this taxable
period is specified in the LOA. DLSU was fully apprised that it was being audited for taxable
year 2003. Corollarily, the assessments for taxable years 2001 and 2002 are void for having been
unspecified on separate LOAs as required under RMO No. 43-90.

Lastly, the Commissioner's claim that DLSU failed to raise the issue of the LOA' s validity at the
CTA Division, and thus, should not have been entertained on appeal, is not accurate.

On the contrary, the CTA En Banc found that the issue of the LOA's validity came up during the
trial.100 DLSU then raised the issue in its memorandum and motion for partial reconsideration
with the CTA Division. DLSU raised it again on appeal to the CTA En Banc. Thus, the CTA En
Banc could, as it did, pass upon the validity of the LOA.101 Besides, the Commissioner had the
opportunity to argue for the validity of the LOA at the CTA En Banc but she chose not to file her
comment and memorandum despite notice.102

III.The CTA correctly admitted

the supplemental evidence
formally offered by DLSU.

The Commissioner objects to the CTA Division's admission of DLSU's supplemental pieces of
documentary evidence.

To recall, DLSU formally offered its supplemental evidence upon filing its motion for
reconsideration with the CTA Division.103 The CTA Division admitted the supplemental
evidence, which proved that a portion of DLSU's rental income was used actually, directly and
exclusively for educational purposes. Consequently, the CTA Division reduced DLSU's tax
liabilities.

We uphold the CTA Division's admission of the supplemental evidence on distinct but mutually
reinforcing grounds, to wit: (1) the Commissioner failed to timely object to the formal offer of
supplemental evidence; and (2) the CTA is not governed strictly by the technical rules of
evidence.

First, the failure to object to the offered evidence renders it admissible, and the court cannot, on
its own, disregard such evidence.104

The Court has held that if a party desires the court to reject the evidence offered, it must so state
in the form of a timely objection and it cannot raise the objection to the evidence for the first
time on appeal.105 Because of a party's failure to timely object, the evidence offered becomes
part of the evidence in the case. As a consequence, all the parties are considered bound by any
outcome arising from the offer of evidence properly presented.106

As disclosed by DLSU, the Commissioner did not oppose the supplemental formal offer of
evidence despite notice.107 The Commissioner objected to the admission of the supplemental
evidence only when the case was on appeal to the CTA En Banc. By the time the Commissioner
raised her objection, it was too late; the formal offer, admission and evaluation of the
supplemental evidence were all fait accompli.

We clarify that while the Commissioner's failure to promptly object had no bearing on the
materiality or sufficiency of the supplemental evidence admitted, she was bound by the outcome
of the CTA Division's assessment of the evidence.108

Second, the CTA is not governed strictly by the technical rules of evidence. The CTA Division's
admission of the formal offer of supplemental evidence, without prompt objection from the
Commissioner, was thus justified.
Notably, this Court had in the past admitted and considered evidence attached to the taxpayers'
motion for reconsideration.1âwphi1

In the case of BPI-Family Savings Bank v. Court of Appeals,109 the tax refund claimant attached
to its motion for reconsideration with the CT A its Final Adjustment Return. The Commissioner,
as in the present case, did not oppose the taxpayer's motion for reconsideration and the admission
of the Final Adjustment Return.110 We thus admitted and gave weight to the Final Adjustment
Return although it was only submitted upon motion for reconsideration.

We held that while it is true that strict procedural rules generally frown upon the submission of
documents after the trial, the law creating the CTA specifically provides that proceedings before
it shall not be governed strictly by the technical rules of evidence111 and that the paramount
consideration remains the ascertainment of truth. We ruled that procedural rules should not bar
courts from considering undisputed facts to arrive at a just determination of a controversy.112

We applied the same reasoning in the subsequent cases of Filinvest Development Corporation v.
Commissioner of Internal Revenue113 and Commissioner of Internal Revenue v. PERF Realty
Corporation,114 where the taxpayers also submitted the supplemental supporting document only
upon filing their motions for reconsideration.

Although the cited cases involved claims for tax refunds, we also dispense with the strict
application of the technical rules of evidence in the present tax assessment case. If anything, the
liberal application of the rules assumes greater force and significance in the case of a taxpayer
who claims a constitutionally granted tax exemption. While the taxpayers in the cited cases
claimed refund of excess tax payments based on the Tax Code,115 DLSU is claiming tax
exemption based on the Constitution. If liberality is afforded to taxpayers who paid more than
they should have under a statute, then with more reason that we should allow a taxpayer to prove
its exemption from tax based on the Constitution.

Hence, we sustain the CTA's admission of DLSU's supplemental offer of evidence not only
because the Commissioner failed to promptly object, but more so because the strict application
of the technical rules of evidence may defeat the intent of the Constitution.

IV. The CTA's appreciation of

evidence is generally binding on
the Court unless compelling
reasons justify otherwise.

It is doctrinal that the Court will not lightly set aside the conclusions reached by the CTA which,
by the very nature of its function of being dedicated exclusively to the resolution of tax
problems, has developed an expertise on the subject, unless there has been an abuse or
improvident exercise of authority.116 We thus accord the findings of fact by the CTA with the
highest respect. These findings of facts can only be disturbed on appeal if they are not supported
by substantial evidence or there is a showing of gross error or abuse on the part of the CTA. In
the absence of any clear and convincing proof to the contrary, this Court must presume that the
CTA rendered a decision which is valid in every respect.117
We sustain the factual findings of the CTA.

The parties failed to raise credible basis for us to disturb the CTA's findings that DLSU had used
actually, directly and exclusively for educational purposes a portion of its assessed income and
that it had remitted the DST payments though an online imprinting machine.

a. DLSU used actually, directly, and exclusively for educational purposes a portion of its
assessed income.

To see how the CTA arrived at its factual findings, we review the process undertaken, from
which it deduced that DLSU successfully proved that it used actually, directly and exclusively
for educational purposes a portion of its rental income.

The CTA reduced DLSU' s deficiency income tax and VAT liabilities in view of the submission
of the supplemental evidence, which consisted of statement of receipts, statement of
disbursement and fund balance and statement of fund changes.118

These documents showed that DLSU borrowed ₱93.86 Million,119 which was used to build the
university's Sports Complex. Based on these pieces of evidence, the CTA found that DLSU' s
rental income from its concessionaires were indeed transmitted and used for the payment of this
loan. The CTA held that the degree of preponderance of evidence was sufficiently met to prove
actual, direct and exclusive use for educational purposes.

The CTA also found that DLSU's rental income from other concessionaires, which were
allegedly deposited to a fund (CF-CPA Account),120 intended for the university's capital
projects, was not proved to have been used actually, directly and exclusively for educational
purposes. The CTA observed that "[DLSU] ... failed to fully account for and substantiate all the
disbursements from the [fund]." Thus, the CTA "cannot ascertain whether rental income from the
[other] concessionaires was indeed used for educational purposes."121

To stress, the CTA's factual findings were based on and supported by the report of the
Independent CPA who reviewed, audited and examined the voluminous documents submitted by
DLSU.

Under the CTA Revised Rules, an Independent CPA's functions include: (a) examination and
verification of receipts, invoices, vouchers and other long accounts; (b) reproduction of, and
comparison of such reproduction with, and certification that the same are faithful copies of
original documents, and pre-marking of documentary exhibits consisting of voluminous
documents; (c) preparation of schedules or summaries containing a chronological listing of the
numbers, dates and amounts covered by receipts or invoices or other relevant documents and the
amount(s) of taxes paid; (d) making findings as to compliance with substantiation
requirements under pertinent tax laws, regulations and jurisprudence; (e) submission of a
formal report with certification of authenticity and veracity of findings and conclusions in the
performance of the audit; (f) testifying on such formal report; and (g) performing such other
functions as the CTA may direct.122
Based on the Independent CPA's report and on its own appreciation of the evidence, the CTA
held that only the portion of the rental income pertaining to the substantiated disbursements (i.e.,
proved by receipts, vouchers, etc.) from the CF-CPA Account was considered as used actually,
directly and exclusively for educational purposes. Consequently, the unaccounted and
unsubstantiated disbursements must be subjected to income tax and VAT.123

The CTA then further reduced DLSU's tax liabilities by cancelling the assessments for taxable
years 2001 and 2002 due to the defective LOA.124

The Court finds that the above fact-finding process undertaken by the CTA shows that it based its
ruling on the evidence on record, which we reiterate, were examined and verified by the
Independent CPA. Thus, we see no persuasive reason to deviate from these factual findings.

However, while we generally respect the factual findings of the CTA, it does not mean that we
are bound by its conclusions. In the present case, we do not agree with the method used by the
CTA to arrive at DLSU' s unsubstantiated rental income (i.e., income not proved to have been
actually, directly and exclusively used for educational purposes).

To recall, the CTA found that DLSU earned a rental income of ₱l0,610,379.00 in taxable year
2003.125 DLSU earned this income from leasing a portion of its premises to: 1) MTG-Sports
Complex, 2) La Casita, 3) Alarey, Inc., 4) Zaide Food Corp., 5) Capri International, and 6) MTO
Bookstore.126

To prove that its rental income was used for educational purposes, DLSU identified the
transactions where the rental income was expended, viz.: 1) ₱4,007,724.00127 used to pay the
loan obtained by DLSU to build the Sports Complex; and 2) ₱6,602,655.00 transferred to the
CF-CPA Account.128

DLSU also submitted documents to the Independent CPA to prove that the ₱6,602,655.00
transferred to the CF-CPA Account was used actually, directly and exclusively for educational
purposes. According to the Independent CPA' findings, DLSU was able to substantiate
disbursements from the CF-CPA Account amounting to ₱6,259,078.30.

Contradicting the findings of the Independent CPA, the CTA concluded that out of the
₱l0,610,379.00 rental income, ₱4,841,066.65 was unsubstantiated, and thus, subject to income
tax and VAT.129

The CTA then concluded that the ratio of substantiated disbursements to the total disbursements
from the CF-CPA Account for taxable year 2003 is only 26.68%.130 The CTA held as follows:

However, as regards petitioner's rental income from Alarey, Inc., Zaide Food Corp., Capri
International and MTO Bookstore, which were transmitted to the CF-CPA Account, petitioner
again failed to fully account for and substantiate all the disbursements from the CF-CPA
Account; thus failing to prove that the rental income derived therein were actually, directly and
exclusively used for educational purposes. Likewise, the findings of the Court-Commissioned
Independent CPA show that the disbursements from the CF-CPA Account for fiscal year 2003
amounts to ₱6,259,078.30 only. Hence, this portion of the rental income, being the substantiated
disbursements of the CF-CPA Account, was considered by the Special First Division as used
actually, directly and exclusively for educational purposes. Since for fiscal year 2003, the total
disbursements per voucher is ₱6,259,078.3 (Exhibit "LL-25-C"), and the total disbursements per
subsidiary ledger amounts to ₱23,463,543.02 (Exhibit "LL-29-C"), the ratio of substantiated
disbursements for fiscal year 2003 is 26.68% (₱6,259,078.30/₱23,463,543.02). Thus, the
substantiated portion of CF-CPA Disbursements for fiscal year 2003, arrived at by multiplying
the ratio of 26.68% with the total rent income added to and used in the CF-CPA Account in the
amount of ₱6,602,655.00 is ₱1,761,588.35.131 (emphasis supplied)

For better understanding, we summarize the CTA's computation as follows:

1. The CTA subtracted the rent income used in the construction of the Sports Complex
(₱4,007,724.00) from the rental income (₱10,610,379.00) earned from the abovementioned
concessionaries. The difference (₱6,602,655.00) was the portion claimed to have been deposited
to the CF-CPA Account.

2. The CTA then subtracted the supposed substantiated portion of CF-CPA disbursements
(₱1,761,308.37) from the ₱6,602,655.00 to arrive at the supposed unsubstantiated portion of the
rental income (₱4,841,066.65).132

3. The substantiated portion of CF-CPA disbursements (₱l,761,308.37)133 was derived by

multiplying the rental income claimed to have been added to the CF-CPA Account
(₱6,602,655.00) by 26.68% or the ratio of substantiated disbursements to total disbursements
(₱23,463,543.02).

4. The 26.68% ratio134 was the result of dividing the substantiated disbursements from the CF-
CPA Account as found by the Independent CPA (₱6,259,078.30) by the total disbursements
(₱23,463,543.02) from the same account.

We find that this system of calculation is incorrect and does not truly give effect to the
constitutional grant of tax exemption to non-stock, non-profit educational institutions. The CTA's
reasoning is flawed because it required DLSU to substantiate an amount that is greater than the
rental income deposited in the CF-CPA Account in 2003.

To reiterate, to be exempt from tax, DLSU has the burden of proving that the proceeds of its
rental income (which amounted to a total of ₱10.61 million)135 were used for educational
purposes. This amount was divided into two parts: (a) the ₱4.0l million, which was used to pay
the loan obtained for the construction of the Sports Complex; and (b) the ₱6.60 million,136
which was transferred to the CF-CPA account.

For year 2003, the total disbursement from the CF-CPA account amounted to ₱23 .46 million.137
These figures, read in light of the constitutional exemption, raises the question: does DLSU
claim that the whole total CF-CPA disbursement of ₱23.46 million is tax-exempt so that it is
required to prove that all these disbursements had been made for educational purposes?
We answer in the negative.

The records show that DLSU never claimed that the total CF-CPA disbursements of ₱23.46
million had been for educational purposes and should thus be tax-exempt; DLSU only claimed
₱10.61 million for tax-exemption and should thus be required to prove that this amount had been
used as claimed.

Of this amount, ₱4.01 had been proven to have been used for educational purposes, as confirmed
by the Independent CPA. The amount in issue is therefore the balance of ₱6.60 million which
was transferred to the CF-CPA which in turn made disbursements of ₱23.46 million for various
general purposes, among them the ₱6.60 million transferred by DLSU.

Significantly, the Independent CPA confirmed that the CF-CPA made disbursements for
educational purposes in year 2003 in the amount ₱6.26 million. Based on these given figures, the
CT A concluded that the expenses for educational purposes that had been coursed through the
CF-CPA should be prorated so that only the portion that ₱6.26 million bears to the total CF-CPA
disbursements should be credited to DLSU for tax exemption.

This approach, in our view, is flawed given the constitutional requirement that revenues actually
and directly used for educational purposes should be tax-exempt. As already mentioned above,
DLSU is not claiming that the whole ₱23.46 million CF-CPA disbursement had been used for
educational purposes; it only claims that ₱6.60 million transferred to CF-CPA had been used for
educational purposes. This was what DLSU needed to prove to have actually and directly used
for educational purposes.

That this fund had been first deposited into a separate fund (the CF -CPA established to fund
capital projects) lends peculiarity to the facts of this case, but does not detract from the fact that
the deposited funds were DLSU revenue funds that had been confirmed and proven to have been
actually and directly used for educational purposes via the CF-CPA. That the CF-CPA might
have had other sources of funding is irrelevant because the assessment in the present case
pertains only to the rental income which DLSU indisputably earned as revenue in 2003. That the
proven CF-CPA funds used for educational purposes should not be prorated as part of its total
CF-CPA disbursements for purposes of crediting to DLSU is also logical because no claim
whatsoever had been made that the totality of the CF-CPA disbursements had been for
educational purposes. No prorating is necessary; to state the obvious, exemption is based on
actual and direct use and this DLSU has indisputably proven.

Based on these considerations, DLSU should therefore be liable only for the difference between
what it claimed and what it has proven. In more concrete terms, DLSU only had to prove that its
rental income for taxable year 2003 (₱10,610,379.00) was used for educational purposes. Hence,
while the total disbursements from the CF-CPA Account amounted to ₱23,463,543.02, DLSU
only had to substantiate its Pl0.6 million rental income, part of which was the ₱6,602,655.00
transferred to the CF-CPA account. Of this latter amount, ₱6.259 million was substantiated to
have been used for educational purposes.
To summarize, we thus revise the tax base for deficiency income tax and VAT for taxable year
2003 as follows:

CTA
Decision138 Revised

Rental income 10,610,379.00 10,610,379.00

Less: Rent income used in construction of the 4,007,724.00 4,007,724.00

Sports Complex

Rental income deposited to the CF-CPA Account 6,602,655.00 6,602,655.00

Less: Substantiated portion of CF-CPA 1,761,588.35 6,259,078.30

disbursements

Tax base for deficiency income tax and VAT 4,841,066.65 343.576.70

On DLSU' s argument that the CTA should have appreciated its evidence in the same way as it
did with the evidence submitted by Ateneo in another separate case, the CTA explained that the
issue in the Ateneo case was not the same as the issue in the present case.

The issue in the Ateneo case was whether or not Ateneo could be held liable to pay income taxes
and VAT under certain BIR and Department of Finance issuances139 that required the
educational institution to own and operate the canteens, or other commercial enterprises within
its campus, as condition for tax exemption. The CTA held that the Constitution does not require
the educational institution to own or operate these commercial establishments to avail of the
exemption.140

Given the lack of complete identity of the issues involved, the CTA held that it had to evaluate
the separate sets of evidence differently. The CTA likewise stressed that DLSU and Ateneo gave
distinct defenses and that its wisdom "cannot be equated on its decision on two different cases
with two different issues."141

DLSU disagrees with the CTA and argues that the entire assessment must be cancelled because it
submitted similar, if not stronger sets of evidence, as Ateneo. We reject DLSU's argument for
being non sequitur. Its reliance on the concept of uniformity of taxation is also incorrect.
First, even granting that Ateneo and DLSU submitted similar evidence, the sufficiency and
materiality of the evidence supporting their respective claims for tax exemption would
necessarily differ because their attendant issues and facts differ.

To state the obvious, the amount of income received by DLSU and by Ateneo during the taxable
years they were assessed varied. The amount of tax assessment also varied. The amount of
income proven to have been used for educational purposes also varied because the amount
substantiated varied.142 Thus, the amount of tax assessment cancelled by the CTA varied.

On the one hand, the BIR assessed DLSU a total tax deficiency of ₱17,303,001.12 for taxable
years 2001, 2002 and 2003. On the other hand, the BIR assessed Ateneo a total deficiency tax of
₱8,864,042.35 for the same period. Notably, DLSU was assessed deficiency DST, while Ateneo
was not.143

Thus, although both Ateneo and DLSU claimed that they used their rental income actually,
directly and exclusively for educational purposes by submitting similar evidence, e.g., the
testimony of their employees on the use of university revenues, the report of the Independent
CPA, their income summaries, financial statements, vouchers, etc., the fact remains that DLSU
failed to prove that a portion of its income and revenues had indeed been used for educational
purposes.

The CTA significantly found that some documents that could have fully supported DLSU's claim
were not produced in court. Indeed, the Independent CPA testified that some disbursements had
not been proven to have been used actually, directly and exclusively for educational
purposes.144

The final nail on the question of evidence is DLSU's own admission that the original of these
documents had not in fact been produced before the CTA although it claimed that there was no
bad faith on its part.145 To our mind, this admission is a good indicator of how the Ateneo and
the DLSU cases varied, resulting in DLSU's failure to substantiate a portion of its claimed
exemption.

Further, DLSU's invocation of Section 5, Rule 130 of the Revised

Rules on Evidence, that the contents of the missing supporting documents were proven by its
recital in some other authentic documents on record,146 can no longer be entertained at this late
stage of the proceeding. The CTA did not rule on this particular claim. The CTA also made no
finding on DLSU' s assertion of lack of bad faith. Besides, it is not our duty to go over these
documents to test the truthfulness of their contents, this Court not being a trier of facts.

Second, DLSU misunderstands the concept of uniformity of taxation.

Equality and uniformity of taxation means that all taxable articles or kinds of property of the
same class shall be taxed at the same rate.147 A tax is uniform when it operates with the same
force and effect in every place where the subject of it is found.148 The concept requires that all
subjects of taxation similarly situated should be treated alike and placed in equal footing.149
In our view, the CTA placed Ateneo and DLSU in equal footing. The CTA treated them alike
because their income proved to have been used actually, directly and exclusively for educational
purposes were exempted from taxes. The CTA equally applied the requirements in the YMCA
case to test if they indeed used their revenues for educational purposes.

DLSU can only assert that the CTA violated the rule on uniformity if it can show that, despite
proving that it used actually, directly and exclusively for educational purposes its income and
revenues, the CTA still affirmed the imposition of taxes. That the DLSU secured a different result
happened because it failed to fully prove that it used actually, directly and exclusively for
educational purposes its revenues and income.

On this point, we remind DLSU that the rule on uniformity of taxation does not mean that
subjects of taxation similarly situated are treated in literally the same way in all and every
occasion. The fact that the Ateneo and DLSU are both non-stock, non-profit educational
institutions, does not mean that the CTA or this Court would similarly decide every case for (or
against) both universities. Success in tax litigation, like in any other litigation, depends to a large
extent on the sufficiency of evidence. DLSU's evidence was wanting, thus, the CTA was correct
in not fully cancelling its tax liabilities.

b. DLSU proved its payment of the DST

The CTA affirmed DLSU's claim that the DST due on its mortgage and loan transactions were
paid and remitted through its bank's On-Line Electronic DST Imprinting Machine. The
Commissioner argues that DLSU is not allowed to use this method of payment because an
educational institution is excluded from the class of taxpayers who can use the On-Line
Electronic DST Imprinting Machine.

We sustain the findings of the CTA. The Commissioner's argument lacks basis in both the Tax
Code and the relevant revenue regulations.

DST on documents, loan agreements, and papers shall be levied, collected and paid for by the
person making, signing, issuing, accepting, or transferring the same.150 The Tax Code provides
that whenever one party to the document enjoys exemption from DST, the other party not exempt
from DST shall be directly liable for the tax. Thus, it is clear that DST shall be payable by any
party to the document, such that the payment and compliance by one shall mean the full
settlement of the DST due on the document.

In the present case, DLSU entered into mortgage and loan agreements with banks. These
agreements are subject to DST.151 For the purpose of showing that the DST on the loan
agreement has been paid, DLSU presented its agreements bearing the imprint showing that DST
on the document has been paid by the bank, its counterparty. The imprint should be sufficient
proof that DST has been paid. Thus, DLSU cannot be further assessed for deficiency DST on the
said documents.

Finally, it is true that educational institutions are not included in the class of taxpayers who can
pay and remit DST through the On-Line Electronic DST Imprinting Machine under RR No. 9-
2000. As correctly held by the CTA, this is irrelevant because it was not DLSU who used the
On-Line Electronic DST Imprinting Machine but the bank that handled its mortgage and loan
transactions. RR No. 9-2000 expressly includes banks in the class of taxpayers that can use the
On-Line Electronic DST Imprinting Machine.

Thus, the Court sustains the finding of the CTA that DLSU proved the

payment of the assessed DST deficiency, except for the unpaid balance of

₱13,265.48.152

WHEREFORE, premises considered, we DENY the petition of the Commissioner of Internal

Revenue in G.R. No. 196596 and AFFIRM the December 10, 2010 decision and March 29,
2011 resolution of the Court of Tax Appeals En Banc in CTA En Banc Case No. 622, except for
the total amount of deficiency tax liabilities of De La Salle University, Inc., which had been
reduced.

We also DENY both the petition of De La Salle University, Inc. in G.R. No. 198841 and the
petition of the Commissioner of Internal Revenue in G.R. No. 198941 and thus AFFIRM the
June 8, 2011 decision and October 4, 2011 resolution of the Court of Tax Appeals En Banc in
CTA En Banc Case No. 671, with the MODIFICATION that the base for the deficiency income
tax and VAT for taxable year 2003 is ₱343,576.70.

SO ORDERED.
G.R. No. L-66838 December 2, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner,

vs.
PROCTER & GAMBLE PHILIPPINE MANUFACTURING CORPORATION and THE
COURT OF TAX APPEALS, respondents.

T.A. Tejada & C.N. Lim for private respondent.

RESOLUTION

FELICIANO, J.:

For the taxable year 1974 ending on 30 June 1974, and the taxable year 1975 ending 30 June
1975, private respondent Procter and Gamble Philippine Manufacturing Corporation ("P&G-
Phil.") declared dividends payable to its parent company and sole stockholder, Procter and
Gamble Co., Inc. (USA) ("P&G-USA"), amounting to P24,164,946.30, from which dividends
the amount of P8,457,731.21 representing the thirty-five percent (35%) withholding tax at source
was deducted.

On 5 January 1977, private respondent P&G-Phil. filed with petitioner Commissioner of Internal
Revenue a claim for refund or tax credit in the amount of P4,832,989.26 claiming, among other
things, that pursuant to Section 24 (b) (1) of the National Internal Revenue Code ("NITC"), 1 as
amended by Presidential Decree No. 369, the applicable rate of withholding tax on the dividends
remitted was only fifteen percent (15%) (and not thirty-five percent [35%]) of the dividends.

There being no responsive action on the part of the Commissioner, P&G-Phil., on 13 July 1977,
filed a petition for review with public respondent Court of Tax Appeals ("CTA") docketed as
CTA Case No. 2883. On 31 January 1984, the CTA rendered a decision ordering petitioner
Commissioner to refund or grant the tax credit in the amount of P4,832,989.00.

On appeal by the Commissioner, the Court through its Second Division reversed the decision of
the CTA and held that:

(a) P&G-USA, and not private respondent P&G-Phil., was the proper party to claim the
refund or tax credit here involved;

(b) there is nothing in Section 902 or other provisions of the US Tax Code that allows a
credit against the US tax due from P&G-USA of taxes deemed to have been paid in the
Philippines equivalent to twenty percent (20%) which represents the difference between
 the regular tax of thirty-five percent (35%) on corporations and the tax of fifteen percent
(15%) on dividends; and

(c) private respondent P&G-Phil. failed to meet certain conditions necessary in order that
"the dividends received by its non-resident parent company in the US (P&G-USA) may
be subject to the preferential tax rate of 15% instead of 35%."

These holdings were questioned in P&G-Phil.'s Motion for Re-consideration and we will deal
with them seriatim in this Resolution resolving that Motion.

1. There are certain preliminary aspects of the question of the capacity of P&G-Phil. to bring the
present claim for refund or tax credit, which need to be examined. This question was raised for
the first time on appeal, i.e., in the proceedings before this Court on the Petition for Review filed
by the Commissioner of Internal Revenue. The question was not raised by the Commissioner on
the administrative level, and neither was it raised by him before the CTA.

We believe that the Bureau of Internal Revenue ("BIR") should not be allowed to defeat an
otherwise valid claim for refund by raising this question of alleged incapacity for the first time
on appeal before this Court. This is clearly a matter of procedure. Petitioner does not pretend that
P&G-Phil., should it succeed in the claim for refund, is likely to run away, as it were, with the
refund instead of transmitting such refund or tax credit to its parent and sole stockholder. It is
commonplace that in the absence of explicit statutory provisions to the contrary, the government
must follow the same rules of procedure which bind private parties. It is, for instance, clear that
the government is held to compliance with the provisions of Circular No. 1-88 of this Court in
exactly the same way that private litigants are held to such compliance, save only in respect of
the matter of filing fees from which the Republic of the Philippines is exempt by the Rules of
Court.

More importantly, there arises here a question of fairness should the BIR, unlike any other
litigant, be allowed to raise for the first time on appeal questions which had not been litigated
either in the lower court or on the administrative level. For, if petitioner had at the earliest
possible opportunity, i.e., at the administrative level, demanded that P&G-Phil. produce an
express authorization from its parent corporation to bring the claim for refund, then P&G-Phil.
would have been able forthwith to secure and produce such authorization before filing the action
in the instant case. The action here was commenced just before expiration of the two (2)-year
prescriptive period.

2. The question of the capacity of P&G-Phil. to bring the claim for refund has substantive
dimensions as well which, as will be seen below, also ultimately relate to fairness.

Under Section 306 of the NIRC, a claim for refund or tax credit filed with the Commissioner of
Internal Revenue is essential for maintenance of a suit for recovery of taxes allegedly
erroneously or illegally assessed or collected:
 Sec. 306. Recovery of tax erroneously or illegally collected. — No suit or proceeding
shall be maintained in any court for the recovery of any national internal revenue tax
hereafter alleged to have been erroneously or illegally assessed or collected, or of any
penalty claimed to have been collected without authority, or of any sum alleged to have
been excessive or in any manner wrongfully collected, until a claim for refund or credit
has been duly filed with the Commissioner of Internal Revenue; but such suit or
proceeding may be maintained, whether or not such tax, penalty, or sum has been paid
under protest or duress. In any case, no such suit or proceeding shall be begun after the
expiration of two years from the date of payment of the tax or penalty regardless of any
supervening cause that may arise after payment: . . . (Emphasis supplied)

Section 309 (3) of the NIRC, in turn, provides:

Sec. 309. Authority of Commissioner to Take Compromises and to Refund Taxes.—The

Commissioner may:

xxx xxx xxx

(3) credit or refund taxes erroneously or illegally received, . . . No credit or refund of taxes or
penalties shall be allowed unless the taxpayer files in writing with the Commissioner a claim for
credit or refund within two (2) years after the payment of the tax or penalty. (As amended by
P.D. No. 69) (Emphasis supplied)

Since the claim for refund was filed by P&G-Phil., the question which arises is: is P&G-Phil. a
"taxpayer" under Section 309 (3) of the NIRC? The term "taxpayer" is defined in our NIRC as
referring to "any person subject to tax imposed by the Title [on Tax on Income]." 2 It thus
becomes important to note that under Section 53 (c) of the NIRC, the withholding agent who is
"required to deduct and withhold any tax" is made " personally liable for such tax" and indeed is
indemnified against any claims and demands which the stockholder might wish to make in
questioning the amount of payments effected by the withholding agent in accordance with the
provisions of the NIRC. The withholding agent, P&G-Phil., is directly and independently liable 3
for the correct amount of the tax that should be withheld from the dividend remittances. The
withholding agent is, moreover, subject to and liable for deficiency assessments, surcharges and
penalties should the amount of the tax withheld be finally found to be less than the amount that
should have been withheld under law.

A "person liable for tax" has been held to be a "person subject to tax" and properly considered a
"taxpayer." 4 The terms liable for tax" and "subject to tax" both connote legal obligation or duty
to pay a tax. It is very difficult, indeed conceptually impossible, to consider a person who is
statutorily made "liable for tax" as not "subject to tax." By any reasonable standard, such a
person should be regarded as a party in interest, or as a person having sufficient legal interest, to
bring a suit for refund of taxes he believes were illegally collected from him.

In Philippine Guaranty Company, Inc. v. Commissioner of Internal Revenue, 5 this Court pointed
out that a withholding agent is in fact the agent both of the government and of the taxpayer, and
that the withholding agent is not an ordinary government agent:
 The law sets no condition for the personal liability of the withholding agent to attach.
The reason is to compel the withholding agent to withhold the tax under all
circumstances. In effect, the responsibility for the collection of the tax as well as the
payment thereof is concentrated upon the person over whom the Government has
jurisdiction. Thus, the withholding agent is constituted the agent of both the Government
and the taxpayer. With respect to the collection and/or withholding of the tax, he is the
Government's agent. In regard to the filing of the necessary income tax return and the
payment of the tax to the Government, he is the agent of the taxpayer. The withholding
agent, therefore, is no ordinary government agent especially because under Section 53
(c) he is held personally liable for the tax he is duty bound to withhold; whereas the
Commissioner and his deputies are not made liable by law. 6 (Emphasis supplied)

If, as pointed out in Philippine Guaranty, the withholding agent is also an agent of the beneficial
owner of the dividends with respect to the filing of the necessary income tax return and with
respect to actual payment of the tax to the government, such authority may reasonably be held to
include the authority to file a claim for refund and to bring an action for recovery of such claim.
This implied authority is especially warranted where, is in the instant case, the withholding agent
is the wholly owned subsidiary of the parent-stockholder and therefore, at all times, under the
effective control of such parent-stockholder. In the circumstances of this case, it seems
particularly unreal to deny the implied authority of P&G-Phil. to claim a refund and to
commence an action for such refund.

We believe that, even now, there is nothing to preclude the BIR from requiring P&G-Phil. to
show some written or telexed confirmation by P&G-USA of the subsidiary's authority to claim
the refund or tax credit and to remit the proceeds of the refund., or to apply the tax credit to some
Philippine tax obligation of, P&G-USA, before actual payment of the refund or issuance of a tax
credit certificate. What appears to be vitiated by basic unfairness is petitioner's position that,
although P&G-Phil. is directly and personally liable to the Government for the taxes and any
deficiency assessments to be collected, the Government is not legally liable for a refund simply
because it did not demand a written confirmation of P&G-Phil.'s implied authority from the very
beginning. A sovereign government should act honorably and fairly at all times, even vis-a-vis
taxpayers.

We believe and so hold that, under the circumstances of this case, P&G-Phil. is properly
regarded as a "taxpayer" within the meaning of Section 309, NIRC, and as impliedly authorized
to file the claim for refund and the suit to recover such claim.

II

1. We turn to the principal substantive question before us: the applicability to the dividend
remittances by P&G-Phil. to P&G-USA of the fifteen percent (15%) tax rate provided for in the
following portion of Section 24 (b) (1) of the NIRC:

(b) Tax on foreign corporations.—

 (1) Non-resident corporation. — A foreign corporation not engaged in trade and business
in the Philippines, . . ., shall pay a tax equal to 35% of the gross income receipt during its
taxable year from all sources within the Philippines, as . . . dividends . . . Provided, still
further, that on dividends received from a domestic corporation liable to tax under this
Chapter, the tax shall be 15% of the dividends, which shall be collected and paid as
provided in Section 53 (d) of this Code, subject to the condition that the country in which
the non-resident foreign corporation, is domiciled shall allow a credit against the tax due
from the non-resident foreign corporation, taxes deemed to have been paid in the
Philippines equivalent to 20% which represents the difference between the regular tax
(35%) on corporations and the tax (15%) on dividends as provided in this Section . . .

The ordinary thirty-five percent (35%) tax rate applicable to dividend remittances to non-resident
corporate stockholders of a Philippine corporation, goes down to fifteen percent (15%) if the
country of domicile of the foreign stockholder corporation "shall allow" such foreign corporation
a tax credit for "taxes deemed paid in the Philippines," applicable against the tax payable to the
domiciliary country by the foreign stockholder corporation. In other words, in the instant case,
the reduced fifteen percent (15%) dividend tax rate is applicable if the USA "shall allow" to
P&G-USA a tax credit for "taxes deemed paid in the Philippines" applicable against the US taxes
of P&G-USA. The NIRC specifies that such tax credit for "taxes deemed paid in the Philippines"
must, as a minimum, reach an amount equivalent to twenty (20) percentage points which
represents the difference between the regular thirty-five percent (35%) dividend tax rate and the
preferred fifteen percent (15%) dividend tax rate.

It is important to note that Section 24 (b) (1), NIRC, does not require that the US must give a
"deemed paid" tax credit for the dividend tax (20 percentage points) waived by the Philippines in
making applicable the preferred divided tax rate of fifteen percent (15%). In other words, our
NIRC does not require that the US tax law deem the parent-corporation to have paid the twenty
(20) percentage points of dividend tax waived by the Philippines. The NIRC only requires that
the US "shall allow" P&G-USA a "deemed paid" tax credit in an amount equivalent to the
twenty (20) percentage points waived by the Philippines.

2. The question arises: Did the US law comply with the above requirement? The relevant
provisions of the US Intemal Revenue Code ("Tax Code") are the following:

Sec. 901 — Taxes of foreign countries and possessions of United States.

(a) Allowance of credit. — If the taxpayer chooses to have the benefits of this subpart,
the tax imposed by this chapter shall, subject to the applicable limitation of section 904,
be credited with the amounts provided in the applicable paragraph of subsection (b) plus,
in the case of a corporation, the taxes deemed to have been paid under sections 902 and
960. Such choice for any taxable year may be made or changed at any time before the
expiration of the period prescribed for making a claim for credit or refund of the tax
imposed by this chapter for such taxable year. The credit shall not be allowed against the
tax imposed by section 531 (relating to the tax on accumulated earnings), against the
additional tax imposed for the taxable year under section 1333 (relating to war loss
recoveries) or under section 1351 (relating to recoveries of foreign expropriation losses),
or against the personal holding company tax imposed by section 541.

(b) Amount allowed. — Subject to the applicable limitation of section 904, the following
amounts shall be allowed as the credit under subsection (a):

(a) Citizens and domestic corporations. — In the case of a citizen of the United
States and of a domestic corporation, the amount of any income, war profits, and
excess profits taxes paid or accrued during the taxable year to any foreign
country or to any possession of the United States; and

xxx xxx xxx

Sec. 902. — Credit for corporate stockholders in foreign corporation.

(A) Treatment of Taxes Paid by Foreign Corporation. — For purposes of this

subject, a domestic corporation which owns at least 10 percent of the voting stock
of a foreign corporation from which it receives dividends in any taxable year
shall —

xxx xxx xxx

(2) to the extent such dividends are paid by such foreign corporation out of
accumulated profits [as defined in subsection (c) (1) (b)] of a year for which such
foreign corporation is a less developed country corporation, be deemed to have
paid the same proportion of any income, war profits, or excess profits taxes paid
or deemed to be paid by such foreign corporation to any foreign country or to any
possession of the United States on or with respect to such accumulated profits,
which the amount of such dividends bears to the amount of such accumulated
profits.

xxx xxx xxx

(c) Applicable Rules

(1) Accumulated profits defined. — For purposes of this section, the term
"accumulated profits" means with respect to any foreign corporation,

(A) for purposes of subsections (a) (1) and (b) (1), the amount of its gains,
profits, or income computed without reduction by the amount of the
income, war profits, and excess profits taxes imposed on or with respect to
such profits or income by any foreign country. . . .; and
 (B) for purposes of subsections (a) (2) and (b) (2), the amount of its gains,
profits, or income in excess of the income, war profits, and excess profits
taxes imposed on or with respect to such profits or income.

The Secretary or his delegate shall have full power to determine from the
accumulated profits of what year or years such dividends were paid, treating
dividends paid in the first 20 days of any year as having been paid from the
accumulated profits of the preceding year or years (unless to his satisfaction
shows otherwise), and in other respects treating dividends as having been paid
from the most recently accumulated gains, profits, or earning. . . . (Emphasis
supplied)

Close examination of the above quoted provisions of the US Tax Code 7 shows the
following:

a. US law (Section 901, Tax Code) grants P&G-USA a tax credit for the amount
of the dividend tax actually paid (i.e., withheld) from the dividend remittances to
P&G-USA;

b. US law (Section 902, US Tax Code) grants to P&G-USA a "deemed paid' tax
credit 8 for a proportionate part of the corporate income tax actually paid to the
Philippines by P&G-Phil.

The parent-corporation P&G-USA is "deemed to have paid" a portion of the Philippine

corporate income tax although that tax was actually paid by its Philippine subsidiary,
P&G-Phil., not by P&G-USA. This "deemed paid" concept merely reflects economic
reality, since the Philippine corporate income tax was in fact paid and deducted from
revenues earned in the Philippines, thus reducing the amount remittable as dividends to
P&G-USA. In other words, US tax law treats the Philippine corporate income tax as if it
came out of the pocket, as it were, of P&G-USA as a part of the economic cost of
carrying on business operations in the Philippines through the medium of P&G-Phil. and
here earning profits. What is, under US law, deemed paid by P&G- USA are not
"phantom taxes" but instead Philippine corporate income taxes actually paid here by
P&G-Phil., which are very real indeed.

It is also useful to note that both (i) the tax credit for the Philippine dividend tax actually
withheld, and (ii) the tax credit for the Philippine corporate income tax actually paid by
P&G Phil. but "deemed paid" by P&G-USA, are tax credits available or applicable
against the US corporate income tax of P&G-USA. These tax credits are allowed because
of the US congressional desire to avoid or reduce double taxation of the same income
stream. 9

In order to determine whether US tax law complies with the requirements for
applicability of the reduced or preferential fifteen percent (15%) dividend tax rate under
Section 24 (b) (1), NIRC, it is necessary:

a. to determine the amount of the 20 percentage points dividend tax waived by the
Philippine government under Section 24 (b) (1), NIRC, and which hence goes to
P&G-USA;

b. to determine the amount of the "deemed paid" tax credit which US tax law
must allow to P&G-USA; and

c. to ascertain that the amount of the "deemed paid" tax credit allowed by US law
is at least equal to the amount of the dividend tax waived by the Philippine
Government.

Amount (a), i.e., the amount of the dividend tax waived by the Philippine government is
arithmetically determined in the following manner:

P100.00 — Pretax net corporate income earned by P&G-Phil.

x 35% — Regular Philippine corporate income tax rate
———
P35.00 — Paid to the BIR by P&G-Phil. as Philippine
corporate income tax.

P100.00
-35.00
———
P65.00 — Available for remittance as dividends to P&G-USA

P65.00 — Dividends remittable to P&G-USA

x 35% — Regular Philippine dividend tax rate under Section 24
——— (b) (1), NIRC
P22.75 — Regular dividend tax

P65.00 — Dividends remittable to P&G-USA

x 15% — Reduced dividend tax rate under Section 24 (b) (1), NIRC
———
P9.75 — Reduced dividend tax

P22.75 — Regular dividend tax under Section 24 (b) (1), NIRC

-9.75 — Reduced dividend tax under Section 24 (b) (1), NIRC
 ———
P13.00 — Amount of dividend tax waived by Philippine
===== government under Section 24 (b) (1), NIRC.

Thus, amount (a) above is P13.00 for every P100.00 of pre-tax net income earned by
P&G-Phil. Amount (a) is also the minimum amount of the "deemed paid" tax credit that
US tax law shall allow if P&G-USA is to qualify for the reduced or preferential dividend
tax rate under Section 24 (b) (1), NIRC.

Amount (b) above, i.e., the amount of the "deemed paid" tax credit which US tax law
allows under Section 902, Tax Code, may be computed arithmetically as follows:

P65.00 — Dividends remittable to P&G-USA

- 9.75 — Dividend tax withheld at the reduced (15%) rate
———
P55.25 — Dividends actually remitted to P&G-USA

P35.00 — Philippine corporate income tax paid by P&G-Phil.

to the BIR

Dividends actually
remitted by P&G-Phil.
to P&G-USA P55.25
——————— = ——— x P35.00 = P29.75 10
Amount of accumulated P65.00 ======
profits earned by
P&G-Phil. in excess
of income tax

Thus, for every P55.25 of dividends actually remitted (after withholding at the rate of
15%) by P&G-Phil. to its US parent P&G-USA, a tax credit of P29.75 is allowed by
Section 902 US Tax Code for Philippine corporate income tax "deemed paid" by the
parent but actually paid by the wholly-owned subsidiary.

Since P29.75 is much higher than P13.00 (the amount of dividend tax waived by the
Philippine government), Section 902, US Tax Code, specifically and clearly complies
with the requirements of Section 24 (b) (1), NIRC.
3. It is important to note also that the foregoing reading of Sections 901 and 902 of the
US Tax Code is identical with the reading of the BIR of Sections 901 and 902 of the US
Tax Code is identical with the reading of the BIR of Sections 901 and 902 as shown by
administrative rulings issued by the BIR.

The first Ruling was issued in 1976, i.e., BIR Ruling No. 76004, rendered by then Acting
Commissioner of Intemal Revenue Efren I. Plana, later Associate Justice of this Court,
the relevant portion of which stated:

However, after a restudy of the decision in the American Chicle Company case
and the provisions of Section 901 and 902 of the U.S. Internal Revenue Code, we
find merit in your contention that our computation of the credit which the U.S. tax
law allows in such cases is erroneous as the amount of tax "deemed paid" to the
Philippine government for purposes of credit against the U.S. tax by the recipient
of dividends includes a portion of the amount of income tax paid by the
corporation declaring the dividend in addition to the tax withheld from the
dividend remitted. In other words, the U.S. government will allow a credit to the
U.S. corporation or recipient of the dividend, in addition to the amount of tax
actually withheld, a portion of the income tax paid by the corporation declaring
the dividend. Thus, if a Philippine corporation wholly owned by a U.S.
corporation has a net income of P100,000, it will pay P25,000 Philippine income
tax thereon in accordance with Section 24(a) of the Tax Code. The net income,
after income tax, which is P75,000, will then be declared as dividend to the U.S.
corporation at 15% tax, or P11,250, will be withheld therefrom. Under the
aforementioned sections of the U.S. Internal Revenue Code, U.S. corporation
receiving the dividend can utilize as credit against its U.S. tax payable on said
dividends the amount of P30,000 composed of:

(1) The tax "deemed paid" or indirectly paid on the dividend arrived at as
follows:

P75,000 x P25,000 = P18,750

———
100,000 **

(2) The amount of 15% of

P75,000 withheld = 11,250
———
P30,000

The amount of P18,750 deemed paid and to be credited against the U.S. tax on
the dividends received by the U.S. corporation from a Philippine subsidiary is
clearly more than 20% requirement of Presidential Decree No. 369 as 20% of
P75,000.00 the dividends to be remitted under the above example, amounts to
P15,000.00 only.
 In the light of the foregoing, BIR Ruling No. 75-005 dated September 10, 1975 is
hereby amended in the sense that the dividends to be remitted by your client to its
parent company shall be subject to the withholding tax at the rate of 15% only.

This ruling shall have force and effect only for as long as the present pertinent
provisions of the U.S. Federal Tax Code, which are the bases of the ruling, are not
revoked, amended and modified, the effect of which will reduce the percentage of
tax deemed paid and creditable against the U.S. tax on dividends remitted by a
foreign corporation to a U.S. corporation. (Emphasis supplied)

The 1976 Ruling was reiterated in, e.g., BIR Ruling dated 22 July 1981 addressed to
Basic Foods Corporation and BIR Ruling dated 20 October 1987 addressed to Castillo,
Laman, Tan and Associates. In other words, the 1976 Ruling of Hon. Efren I. Plana was
reiterated by the BIR even as the case at bar was pending before the CTA and this Court.

4. We should not overlook the fact that the concept of "deemed paid" tax credit, which is
embodied in Section 902, US Tax Code, is exactly the same "deemed paid" tax credit
found in our NIRC and which Philippine tax law allows to Philippine corporations which
have operations abroad (say, in the United States) and which, therefore, pay income taxes
to the US government.

Section 30 (c) (3) and (8), NIRC, provides:

(d) Sec. 30. Deductions from Gross Income.—In computing net income, there
shall be allowed as deductions — . . .

(c) Taxes. — . . .

xxx xxx xxx

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

(a) Citizen and Domestic Corporation. — In the case of a citizen of the

Philippines and of domestic corporation, the amount of net income, war profits or
excess profits, taxes paid or accrued during the taxable year to any foreign
country. (Emphasis supplied)

Under Section 30 (c) (3) (a), NIRC, above, the BIR must give a tax credit to a Philippine
corporation for taxes actually paid by it to the US government—e.g., for taxes collected
by the US government on dividend remittances to the Philippine corporation. This
Section of the NIRC is the equivalent of Section 901 of the US Tax Code.

Section 30 (c) (8), NIRC, is practically identical with Section 902 of the US Tax Code,
and provides as follows:
 (8) Taxes of foreign subsidiary. — For the purposes of this subsection a domestic
corporation which owns a majority of the voting stock of a foreign corporation
from which it receives dividends in any taxable year shall be deemed to have paid
the same proportion of any income, war-profits, or excess-profits taxes paid by
such foreign corporation to any foreign country, upon or with respect to the
accumulated profits of such foreign corporation from which such dividends were
paid, which the amount of such dividends bears to the amount of such
accumulated profits: Provided, That the amount of tax deemed to have been paid
under this subsection shall in no case exceed the same proportion of the tax
against which credit is taken which the amount of such dividends bears to the
amount of the entire net income of the domestic corporation in which such
dividends are included. The term "accumulated profits" when used in this
subsection reference to a foreign corporation, means the amount of its gains,
profits, or income in excess of the income, war-profits, and excess-profits taxes
imposed upon or with respect to such profits or income; and the Commissioner of
Internal Revenue shall have full power to determine from the accumulated profits
of what year or years such dividends were paid; treating dividends paid in the first
sixty days of any year as having been paid from the accumulated profits of the
preceding year or years (unless to his satisfaction shown otherwise), and in other
respects treating dividends as having been paid from the most recently
accumulated gains, profits, or earnings. In the case of a foreign corporation, the
income, war-profits, and excess-profits taxes of which are determined on the basis
of an accounting period of less than one year, the word "year" as used in this
subsection shall be construed to mean such accounting period. (Emphasis
supplied)

Under the above quoted Section 30 (c) (8), NIRC, the BIR must give a tax credit to a
Philippine parent corporation for taxes "deemed paid" by it, that is, e.g., for taxes paid to
the US by the US subsidiary of a Philippine-parent corporation. The Philippine parent or
corporate stockholder is "deemed" under our NIRC to have paid a proportionate part of
the US corporate income tax paid by its US subsidiary, although such US tax was
actually paid by the subsidiary and not by the Philippine parent.

Clearly, the "deemed paid" tax credit which, under Section 24 (b) (1), NIRC, must be allowed by
US law to P&G-USA, is the same "deemed paid" tax credit that Philippine law allows to a
Philippine corporation with a wholly- or majority-owned subsidiary in (for instance) the US. The
"deemed paid" tax credit allowed in Section 902, US Tax Code, is no more a credit for "phantom
taxes" than is the "deemed paid" tax credit granted in Section 30 (c) (8), NIRC.

III

1. The Second Division of the Court, in holding that the applicable dividend tax rate in the
instant case was the regular thirty-five percent (35%) rate rather than the reduced rate of fifteen
percent (15%), held that P&G-Phil. had failed to prove that its parent, P&G-USA, had in fact
been given by the US tax authorities a "deemed paid" tax credit in the amount required by
Section 24 (b) (1), NIRC.

We believe, in the first place, that we must distinguish between the legal question before this
Court from questions of administrative implementation arising after the legal question has been
answered. The basic legal issue is of course, this: which is the applicable dividend tax rate in the
instant case: the regular thirty-five percent (35%) rate or the reduced fifteen percent (15%) rate?
The question of whether or not P&G-USA is in fact given by the US tax authorities a "deemed
paid" tax credit in the required amount, relates to the administrative implementation of the
applicable reduced tax rate.

In the second place, Section 24 (b) (1), NIRC, does not in fact require that the "deemed paid" tax
credit shall have actually been granted before the applicable dividend tax rate goes down from
thirty-five percent (35%) to fifteen percent (15%). As noted several times earlier, Section 24 (b)
(1), NIRC, merely requires, in the case at bar, that the USA "shall allow a credit against the
tax due from [P&G-USA for] taxes deemed to have been paid in the Philippines . . ." There is
neither statutory provision nor revenue regulation issued by the Secretary of Finance requiring
the actual grant of the "deemed paid" tax credit by the US Internal Revenue Service to P&G-
USA before the preferential fifteen percent (15%) dividend rate becomes applicable. Section 24
(b) (1), NIRC, does not create a tax exemption nor does it provide a tax credit; it is a provision
which specifies when a particular (reduced) tax rate is legally applicable.

In the third place, the position originally taken by the Second Division results in a severe
practical problem of administrative circularity. The Second Division in effect held that the
reduced dividend tax rate is not applicable until the US tax credit for "deemed paid" taxes is
actually given in the required minimum amount by the US Internal Revenue Service to P&G-
USA. But, the US "deemed paid" tax credit cannot be given by the US tax authorities unless
dividends have actually been remitted to the US, which means that the Philippine dividend tax, at
the rate here applicable, was actually imposed and collected. 11 It is this practical or operating
circularity that is in fact avoided by our BIR when it issues rulings that the tax laws of particular
foreign jurisdictions (e.g., Republic of Vanuatu 12 Hongkong, 13 Denmark, 14 etc.) comply with
the requirements set out in Section 24 (b) (1), NIRC, for applicability of the fifteen percent
(15%) tax rate. Once such a ruling is rendered, the Philippine subsidiary begins to withhold at the
reduced dividend tax rate.

A requirement relating to administrative implementation is not properly imposed as a condition

for the applicability, as a matter of law, of a particular tax rate. Upon the other hand, upon the
determination or recognition of the applicability of the reduced tax rate, there is nothing to
prevent the BIR from issuing implementing regulations that would require P&G Phil., or any
Philippine corporation similarly situated, to certify to the BIR the amount of the "deemed paid"
tax credit actually subsequently granted by the US tax authorities to P&G-USA or a US parent
corporation for the taxable year involved. Since the US tax laws can and do change, such
implementing regulations could also provide that failure of P&G-Phil. to submit such
certification within a certain period of time, would result in the imposition of a deficiency
assessment for the twenty (20) percentage points differential. The task of this Court is to settle
which tax rate is applicable, considering the state of US law at a given time. We should leave
details relating to administrative implementation where they properly belong — with the BIR.

2. An interpretation of a tax statute that produces a revenue flow for the government is not, for
that reason alone, necessarily the correct reading of the statute. There are many tax statutes or
provisions which are designed, not to trigger off an instant surge of revenues, but rather to
achieve longer-term and broader-gauge fiscal and economic objectives. The task of our Court is
to give effect to the legislative design and objectives as they are written into the statute even if,
as in the case at bar, some revenues have to be foregone in that process.

The economic objectives sought to be achieved by the Philippine Government by reducing the
thirty-five percent (35%) dividend rate to fifteen percent (15%) are set out in the preambular
clauses of P.D. No. 369 which amended Section 24 (b) (1), NIRC, into its present form:

WHEREAS, it is imperative to adopt measures responsive to the requirements of a

developing economy foremost of which is the financing of economic development
programs;

WHEREAS, nonresident foreign corporations with investments in the Philippines are

taxed on their earnings from dividends at the rate of 35%;

WHEREAS, in order to encourage more capital investment for large projects an

appropriate tax need be imposed on dividends received by non-resident foreign
corporations in the same manner as the tax imposed on interest on foreign loans;

xxx xxx xxx

(Emphasis supplied)

More simply put, Section 24 (b) (1), NIRC, seeks to promote the in-flow of foreign equity
investment in the Philippines by reducing the tax cost of earning profits here and thereby
increasing the net dividends remittable to the investor. The foreign investor, however, would not
benefit from the reduction of the Philippine dividend tax rate unless its home country gives it
some relief from double taxation (i.e., second-tier taxation) (the home country would simply
have more "post-R.P. tax" income to subject to its own taxing power) by allowing the investor
additional tax credits which would be applicable against the tax payable to such home country.
Accordingly, Section 24 (b) (1), NIRC, requires the home or domiciliary country to give the
investor corporation a "deemed paid" tax credit at least equal in amount to the twenty (20)
percentage points of dividend tax foregone by the Philippines, in the assumption that a positive
incentive effect would thereby be felt by the investor.

The net effect upon the foreign investor may be shown arithmetically in the following manner:
 P65.00 — Dividends remittable to P&G-USA (please
see page 392 above
- 9.75 — Reduced R.P. dividend tax withheld by P&G-Phil.
———
P55.25 — Dividends actually remitted to P&G-USA

P55.25
x 46% — Maximum US corporate income tax rate
———
P25.415—US corporate tax payable by P&G-USA
without tax credits

P25.415
- 9.75 — US tax credit for RP dividend tax withheld by P&G-Phil.
at 15% (Section 901, US Tax Code)
———
P15.66 — US corporate income tax payable after Section 901
——— tax credit.

P55.25
- 15.66
———
P39.59 — Amount received by P&G-USA net of R.P. and U.S.
===== taxes without "deemed paid" tax credit.

P25.415
- 29.75 — "Deemed paid" tax credit under Section 902 US
——— Tax Code (please see page 18 above)

- 0 - — US corporate income tax payable on dividends

====== remitted by P&G-Phil. to P&G-USA after
Section 902 tax credit.

P55.25 — Amount received by P&G-USA net of RP and US

====== taxes after Section 902 tax credit.

It will be seen that the "deemed paid" tax credit allowed by Section 902, US Tax Code, could
offset the US corporate income tax payable on the dividends remitted by P&G-Phil. The result,
in fine, could be that P&G-USA would after US tax credits, still wind up with P55.25, the full
amount of the dividends remitted to P&G-USA net of Philippine taxes. In the calculation of the
Philippine Government, this should encourage additional investment or re-investment in the
Philippines by P&G-USA.

3. It remains only to note that under the Philippines-United States Convention "With Respect to
Taxes on Income," 15 the Philippines, by a treaty commitment, reduced the regular rate of
dividend tax to a maximum of twenty percent (20%) of the gross amount of dividends paid to US
parent corporations:

Art 11. — Dividends

xxx xxx xxx

(2) The rate of tax imposed by one of the Contracting States on dividends derived from
sources within that Contracting State by a resident of the other Contracting State shall not
exceed —

(a) 25 percent of the gross amount of the dividend; or

(b) When the recipient is a corporation, 20 percent of the gross amount of the dividend if
during the part of the paying corporation's taxable year which precedes the date of
payment of the dividend and during the whole of its prior taxable year (if any), at least
10 percent of the outstanding shares of the voting stock of the paying corporation was
owned by the recipient corporation.

xxx xxx xxx

(Emphasis supplied)

The Tax Convention, at the same time, established a treaty obligation on the part of the United
States that it "shall allow" to a US parent corporation receiving dividends from its Philippine
subsidiary "a [tax] credit for the appropriate amount of taxes paid or accrued to the Philippines
by the Philippine [subsidiary] —. 16 This is, of course, precisely the "deemed paid" tax credit
provided for in Section 902, US Tax Code, discussed above. Clearly, there is here on the part of
the Philippines a deliberate undertaking to reduce the regular dividend tax rate of twenty percent
(20%) is a maximum rate, there is still a differential or additional reduction of five (5) percentage
points which compliance of US law (Section 902) with the requirements of Section 24 (b) (1),
NIRC, makes available in respect of dividends from a Philippine subsidiary.

We conclude that private respondent P&G-Phil, is entitled to the tax refund or tax credit which it
seeks.

WHEREFORE, for all the foregoing, the Court Resolved to GRANT private respondent's Motion
for Reconsideration dated 11 May 1988, to SET ASIDE the Decision of the and Division of the
Court promulgated on 15 April 1988, and in lieu thereof, to REINSTATE and AFFIRM the
Decision of the Court of Tax Appeals in CTA Case No. 2883 dated 31 January 1984 and to
DENY the Petition for Review for lack of merit. No pronouncement as to costs.
G.R. No. 172087 March 15, 2011

PHILIPPINE AMUSEMENT AND GAMING CORPORATION (PAGCOR), Petitioner,

vs.
THE BUREAU OF INTERNAL REVENUE (BIR), represented herein by HON. JOSE
MARIO BUÑAG, in his official capacity as COMMISSIONER OF INTERNAL
REVENUE, Public Respondent,
JOHN DOE and JANE DOE, who are persons acting for, in behalf, or under the authority
of Respondent. Public and Private Respondents.

DECISION

PERALTA, J.:

For resolution of this Court is the Petition for Certiorari and Prohibition1 with prayer for the
issuance of a Temporary Restraining Order and/or Preliminary Injunction, dated April 17, 2006,
of petitioner Philippine Amusement and Gaming Corporation (PAGCOR), seeking the
declaration of nullity of Section 1 of Republic Act (R.A.) No. 9337 insofar as it amends Section
27 (c) of the National Internal Revenue Code of 1997, by excluding petitioner from exemption
from corporate income tax for being repugnant to Sections 1 and 10 of Article III of the
Constitution. Petitioner further seeks to prohibit the implementation of Bureau of Internal
Revenue (BIR) Revenue Regulations No. 16-2005 for being contrary to law.

The undisputed facts follow.

PAGCOR was created pursuant to Presidential Decree (P.D.) No. 1067-A2 on January 1, 1977.
Simultaneous to its creation, P.D. No. 1067-B3 (supplementing P.D. No. 1067-A) was issued
exempting PAGCOR from the payment of any type of tax, except a franchise tax of five percent
(5%) of the gross revenue.4 Thereafter, on June 2, 1978, P.D. No. 1399 was issued expanding the
scope of PAGCOR's exemption.5

To consolidate the laws pertaining to the franchise and powers of PAGCOR, P.D. No. 18696 was
issued. Section 13 thereof reads as follows:

Sec. 13. Exemptions. — x x x

(1) Customs Duties, taxes and other imposts on importations. - All importations of
equipment, vehicles, automobiles, boats, ships, barges, aircraft and such other gambling
paraphernalia, including accessories or related facilities, for the sole and exclusive use of
the casinos, the proper and efficient management and administration thereof and such
other clubs, recreation or amusement places to be established under and by virtue of this
Franchise shall be exempt from the payment of duties, taxes and other imposts, including
all kinds of fees, levies, or charges of any kind or nature.
Vessels and/or accessory ferry boats imported or to be imported by any corporation
having existing contractual arrangements with the Corporation, for the sole and exclusive
use of the casino or to be used to service the operations and requirements of the casino,
shall likewise be totally exempt from the payment of all customs duties, taxes and other
imposts, including all kinds of fees, levies, assessments or charges of any kind or nature,
whether National or Local.

(2) Income and other taxes. - (a) Franchise Holder: No tax of any kind or form, income or
otherwise, as well as fees, charges, or levies of whatever nature, whether National or
Local, shall be assessed and collected under this Franchise from the Corporation; nor
shall any form of tax or charge attach in any way to the earnings of the Corporation,
except a Franchise Tax of five percent (5%)of the gross revenue or earnings derived by
the Corporation from its operation under this Franchise. Such tax shall be due and
payable quarterly to the National Government and shall be in lieu of all kinds of taxes,
levies, fees or assessments of any kind, nature or description, levied, established, or
collected by any municipal, provincial or national government authority.

(b) Others: The exemption herein granted for earnings derived from the operations
conducted under the franchise, specifically from the payment of any tax, income
or otherwise, as well as any form of charges, fees or levies, shall inure to the
benefit of and extend to corporation(s), association(s), agency(ies), or
individual(s) with whom the Corporation or operator has any contractual
relationship in connection with the operations of the casino(s) authorized to be
conducted under this Franchise and to those receiving compensation or other
remuneration from the Corporation as a result of essential facilities furnished
and/or technical services rendered to the Corporation or operator.

The fee or remuneration of foreign entertainers contracted by the Corporation or operator

in pursuance of this provision shall be free of any tax.

(3) Dividend Income. − Notwithstanding any provision of law to the contrary, in the event
the Corporation should declare a cash dividend income corresponding to the participation
of the private sector shall, as an incentive to the beneficiaries, be subject only to a final
flat income rate of ten percent (10%) of the regular income tax rates. The dividend
income shall not in such case be considered as part of the beneficiaries' taxable income;
provided, however, that such dividend income shall be totally exempted from income or
other form of taxes if invested within six (6) months from the date the dividend income is
received in the following:

(a) operation of the casino(s) or investments in any affiliate activity that will
ultimately redound to the benefit of the Corporation; or any other corporation with
whom the Corporation has any existing arrangements in connection with or
related to the operations of the casino(s);

(b) Government bonds, securities, treasury notes, or government debentures; or

 (c) BOI-registered or export-oriented corporation(s).7

PAGCOR's tax exemption was removed in June 1984 through P.D. No. 1931, but it was later
restored by Letter of Instruction No. 1430, which was issued in September 1984.

On January 1, 1998, R.A. No. 8424,8 otherwise known as the National Internal Revenue Code of
1997, took effect. Section 27 (c) of R.A. No. 8424 provides that government-owned and
controlled corporations (GOCCs) shall pay corporate income tax, except petitioner PAGCOR,
the Government Service and Insurance Corporation, the Social Security System, the Philippine
Health Insurance Corporation, and the Philippine Charity Sweepstakes Office, thus:

(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The

provisions of existing special general laws to the contrary notwithstanding, all corporations,
agencies or instrumentalities owned and controlled by the Government, except the Government
Service and Insurance Corporation (GSIS), the Social Security System (SSS), the Philippine
Health Insurance Corporation (PHIC), the Philippine Charity Sweepstakes Office (PCSO), and
the Philippine Amusement and Gaming Corporation (PAGCOR), shall pay such rate of tax upon
their taxable income as are imposed by this Section upon corporations or associations engaged in
similar business, industry, or activity.9

With the enactment of R.A. No. 933710 on May 24, 2005, certain sections of the National Internal
Revenue Code of 1997 were amended. The particular amendment that is at issue in this case is
Section 1 of R.A. No. 9337, which amended Section 27 (c) of the National Internal Revenue
Code of 1997 by excluding PAGCOR from the enumeration of GOCCs that are exempt from
payment of corporate income tax, thus:

(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The

provisions of existing special general laws to the contrary notwithstanding, all corporations,
agencies, or instrumentalities owned and controlled by the Government, except the Government
Service and Insurance Corporation (GSIS), the Social Security System (SSS), the Philippine
Health Insurance Corporation (PHIC), and the Philippine Charity Sweepstakes Office (PCSO),
shall pay such rate of tax upon their taxable income as are imposed by this Section upon
corporations or associations engaged in similar business, industry, or activity.

Different groups came to this Court via petitions for certiorari and prohibition11 assailing the
validity and constitutionality of R.A. No. 9337, in particular:

1) Section 4, which imposes a 10% Value Added Tax (VAT) on sale of goods and
properties; Section 5, which imposes a 10% VAT on importation of goods; and Section 6,
which imposes a 10% VAT on sale of services and use or lease of properties, all contain a
uniform proviso authorizing the President, upon the recommendation of the Secretary of
Finance, to raise the VAT rate to 12%. The said provisions were alleged to be violative of
Section 28 (2), Article VI of the Constitution, which section vests in Congress the
exclusive authority to fix the rate of taxes, and of Section 1, Article III of the Constitution
on due process, as well as of Section 26 (2), Article VI of the Constitution, which section
provides for the "no amendment rule" upon the last reading of a bill;
 2) Sections 8 and 12 were alleged to be violative of Section 1, Article III of the
Constitution, or the guarantee of equal protection of the laws, and Section 28 (1), Article
VI of the Constitution; and

3) other technical aspects of the passage of the law, questioning the manner it was passed.

On September 1, 2005, the Court dismissed all the petitions and upheld the constitutionality of
R.A. No. 9337.12

On the same date, respondent BIR issued Revenue Regulations (RR) No. 16-2005,13 specifically
identifying PAGCOR as one of the franchisees subject to 10% VAT imposed under Section 108
of the National Internal Revenue Code of 1997, as amended by R.A. No. 9337. The said revenue
regulation, in part, reads:

Sec. 4. 108-3. Definitions and Specific Rules on Selected Services. —

xxxx

(h) x x x

Gross Receipts of all other franchisees, other than those covered by Sec. 119 of the Tax Code,
regardless of how their franchisees may have been granted, shall be subject to the 10% VAT
imposed under Sec.108 of the Tax Code. This includes, among others, the Philippine Amusement
and Gaming Corporation (PAGCOR), and its licensees or franchisees.

Hence, the present petition for certiorari.

PAGCOR raises the following issues:

WHETHER OR NOT RA 9337, SECTION 1 (C) IS NULL AND VOID AB INITIO FOR BEING
REPUGNANT TO THE EQUAL PROTECTION [CLAUSE] EMBODIED IN SECTION 1,
ARTICLE III OF THE 1987 CONSTITUTION.

II

WHETHER OR NOT RA 9337, SECTION 1 (C) IS NULL AND VOID AB INITIO FOR BEING
REPUGNANT TO THE NON-IMPAIRMENT [CLAUSE] EMBODIED IN SECTION 10,
ARTICLE III OF THE 1987 CONSTITUTION.

III

WHETHER OR NOT RR 16-2005, SECTION 4.108-3, PARAGRAPH (H) IS NULL AND

VOID AB INITIO FOR BEING BEYOND THE SCOPE OF THE BASIC LAW, RA 8424,
SECTION 108, INSOFAR AS THE SAID REGULATION IMPOSED VAT ON THE SERVICES
OF THE PETITIONER AS WELL AS PETITIONER’S LICENSEES OR FRANCHISEES
WHEN THE BASIC LAW, AS INTERPRETED BY APPLICABLE JURISPRUDENCE, DOES
NOT IMPOSE VAT ON PETITIONER OR ON PETITIONER’S LICENSEES OR
FRANCHISEES.14

The BIR, in its Comment15 dated December 29, 2006, counters:

SECTION 1 OF R.A. NO. 9337 AND SECTION 13 (2) OF P.D. 1869 ARE BOTH VALID AND
CONSTITUTIONAL PROVISIONS OF LAWS THAT SHOULD BE HARMONIOUSLY
CONSTRUED TOGETHER SO AS TO GIVE EFFECT TO ALL OF THEIR PROVISIONS
WHENEVER POSSIBLE.

II

SECTION 1 OF R.A. NO. 9337 IS NOT VIOLATIVE OF SECTION 1 AND SECTION 10,
ARTICLE III OF THE 1987 CONSTITUTION.

III

BIR REVENUE REGULATIONS ARE PRESUMED VALID AND CONSTITUTIONAL

UNTIL STRICKEN DOWN BY LAWFUL AUTHORITIES.

The Office of the Solicitor General (OSG), by way of Manifestation In Lieu of Comment,16
concurred with the arguments of the petitioner. It added that although the State is free to select
the subjects of taxation and that the inequity resulting from singling out a particular class for
taxation or exemption is not an infringement of the constitutional limitation, a tax law must
operate with the same force and effect to all persons, firms and corporations placed in a similar
situation. Furthermore, according to the OSG, public respondent BIR exceeded its statutory
authority when it enacted RR No. 16-2005, because the latter's provisions are contrary to the
mandates of P.D. No. 1869 in relation to R.A. No. 9337.

The main issue is whether or not PAGCOR is still exempt from corporate income tax and VAT
with the enactment of R.A. No. 9337.

After a careful study of the positions presented by the parties, this Court finds the petition partly
meritorious.

Under Section 1 of R.A. No. 9337, amending Section 27 (c) of the National Internal Revenue
Code of 1977, petitioner is no longer exempt from corporate income tax as it has been effectively
omitted from the list of GOCCs that are exempt from it. Petitioner argues that such omission is
unconstitutional, as it is violative of its right to equal protection of the laws under Section 1,
Article III of the Constitution:
Sec. 1. No person shall be deprived of life, liberty, or property without due process of law, nor
shall any person be denied the equal protection of the laws.

In City of Manila v. Laguio, Jr.,17 this Court expounded the meaning and scope of equal
protection, thus:

Equal protection requires that all persons or things similarly situated should be treated alike, both
as to rights conferred and responsibilities imposed. Similar subjects, in other words, should not
be treated differently, so as to give undue favor to some and unjustly discriminate against others.
The guarantee means that no person or class of persons shall be denied the same protection of
laws which is enjoyed by other persons or other classes in like circumstances. The "equal
protection of the laws is a pledge of the protection of equal laws." It limits governmental
discrimination. The equal protection clause extends to artificial persons but only insofar as their
property is concerned.

xxxx

Legislative bodies are allowed to classify the subjects of legislation. If the classification is
reasonable, the law may operate only on some and not all of the people without violating the
equal protection clause. The classification must, as an indispensable requisite, not be arbitrary.
To be valid, it must conform to the following requirements:

1) It must be based on substantial distinctions.

2) It must be germane to the purposes of the law.

3) It must not be limited to existing conditions only.

4) It must apply equally to all members of the class.18

It is not contested that before the enactment of R.A. No. 9337, petitioner was one of the five
GOCCs exempted from payment of corporate income tax as shown in R.A. No. 8424, Section 27
(c) of which, reads:

(c) Government-owned or Controlled Corporations, Agencies or Instrumentalities. - The

provisions of existing special or general laws to the contrary notwithstanding, all corporations,
agencies or instrumentalities owned and controlled by the Government, except the Government
Service and Insurance Corporation (GSIS), the Social Security System (SSS), the Philippine
Health Insurance Corporation (PHIC), the Philippine Charity Sweepstakes Office (PCSO), and
the Philippine Amusement and Gaming Corporation (PAGCOR), shall pay such rate of tax upon
their taxable income as are imposed by this Section upon corporations or associations engaged in
similar business, industry, or activity.19

A perusal of the legislative records of the Bicameral Conference Meeting of the Committee on
Ways on Means dated October 27, 1997 would show that the exemption of PAGCOR from the
payment of corporate income tax was due to the acquiescence of the Committee on Ways on
Means to the request of PAGCOR that it be exempt from such tax.20 The records of the
Bicameral Conference Meeting reveal:

HON. R. DIAZ. The other thing, sir, is we --- I noticed we imposed a tax on lotto winnings.

CHAIRMAN ENRILE. Wala na, tinanggal na namin yon.

HON. R. DIAZ. Tinanggal na ba natin yon?

CHAIRMAN ENRILE. Oo.

HON. R. DIAZ. Because I was wondering whether we covered the tax on --- Whether on a
universal basis, we included a tax on cockfighting winnings.

CHAIRMAN ENRILE. No, we removed the ---

HON. R. DIAZ. I . . . (inaudible) natin yong lotto?

CHAIRMAN ENRILE. Pati PAGCOR tinanggal upon request.

CHAIRMAN JAVIER. Yeah, Philippine Insurance Commission.

CHAIRMAN ENRILE. Philippine Insurance --- Health, health ba. Yon ang request ng Chairman,
I will accept. (laughter) Pag-Pag-ibig yon, maliliit na sa tao yon.

HON. ROXAS. Mr. Chairman, I wonder if in the revenue gainers if we factored in an amount
that would reflect the VAT and other sales taxes---

CHAIRMAN ENRILE. No, we’re talking of this measure only. We will not --- (discontinued)

HON. ROXAS. No, no, no, no, from the --- arising from the exemption. Assuming that when we
release the money into the hands of the public, they will not use that to --- for wallpaper. They
will spend that eh, Mr. Chairman. So when they spend that---

CHAIRMAN ENRILE. There’s a VAT.

HON. ROXAS. There will be a VAT and there will be other sales taxes no. Is there a
quantification? Is there an approximation?

CHAIRMAN JAVIER. Not anything.

HON. ROXAS. So, in effect, we have sterilized that entire seven billion. In effect, it is not
circulating in the economy which is unrealistic.
CHAIRMAN ENRILE. It does, it does, because this is taken and spent by government,
somebody receives it in the form of wages and supplies and other services and other goods. They
are not being taken from the public and stored in a vault.

CHAIRMAN JAVIER. That 7.7 loss because of tax exemption. That will be extra income for the
taxpayers.

HON. ROXAS. Precisely, so they will be spending it.21

The discussion above bears out that under R.A. No. 8424, the exemption of PAGCOR from
paying corporate income tax was not based on a classification showing substantial distinctions
which make for real differences, but to reiterate, the exemption was granted upon the request of
PAGCOR that it be exempt from the payment of corporate income tax.

With the subsequent enactment of R.A. No. 9337, amending R.A. No. 8424, PAGCOR has been
excluded from the enumeration of GOCCs that are exempt from paying corporate income tax.
The records of the Bicameral Conference Meeting dated April 18, 2005, of the Committee on the
Disagreeing Provisions of Senate Bill No. 1950 and House Bill No. 3555, show that it is the
legislative intent that PAGCOR be subject to the payment of corporate income tax, thus:

THE CHAIRMAN (SEN. RECTO). Yes, Osmeña, the proponent of the amendment.

SEN. OSMEÑA. Yeah. Mr. Chairman, one of the reasons why we're even considering this VAT
bill is we want to show the world who our creditors, that we are increasing official revenues that
go to the national budget. Unfortunately today, Pagcor is unofficial.

Now, in 2003, I took a quick look this morning, Pagcor had a net income of 9.7 billion after
paying some small taxes that they are subjected to. Of the 9.7 billion, they claim they remitted to
national government seven billion. Pagkatapos, there are other specific remittances like to the
Philippine Sports Commission, etc., as mandated by various laws, and then about 400 million to
the President's Social Fund. But all in all, their net profit today should be about 12 billion. That's
why I am questioning this two billion. Because while essentially they claim that the money
goes to government, and I will accept that just for the sake of argument. It does not pass
through the appropriation process. And I think that at least if we can capture 35 percent or
32 percent through the budgetary process, first, it is reflected in our official income of
government which is applied to the national budget, and secondly, it goes through what is
constitutionally mandated as Congress appropriating and defining where the money is
spent and not through a board of directors that has absolutely no accountability.

REP. PUENTEBELLA. Well, with all due respect, Mr. Chairman, follow up lang.

There is wisdom in the comments of my good friend from Cebu, Senator Osmeña.

SEN. OSMEÑA. And Negros.

REP. PUENTEBELLA. And Negros at the same time ay Kasimanwa. But I would not want to
put my friends from the Department of Finance in a difficult position, but may we know your
comments on this knowing that as Senator Osmeña just mentioned, he said, "I accept that that a
lot of it is going to spending for basic services," you know, going to most, I think, supposedly a
lot or most of it should go to government spending, social services and the like. What is your
comment on this? This is going to affect a lot of services on the government side.

THE CHAIRMAN (REP. LAPUS). Mr. Chair, Mr. Chair.

SEN. OSMEÑA. It goes from pocket to the other, Monico.

REP. PUENTEBELLA. I know that. But I wanted to ask them, Mr. Senator, because you may
have your own pre-judgment on this and I don't blame you. I don't blame you. And I know you
have your own research. But will this not affect a lot, the disbursements on social services and
other?

REP. LOCSIN. Mr. Chairman. Mr. Chairman, if I can add to that question also. Wouldn't it be
easier for you to explain to, say, foreign creditors, how do you explain to them that if there is a
fiscal gap some of our richest corporations has [been] spared [from] taxation by the government
which is one rich source of revenues. Now, why do you save, why do you spare certain
government corporations on that, like Pagcor? So, would it be easier for you to make an
argument if everything was exposed to taxation?

REP. TEVES. Mr. Chair, please.

THE CHAIRMAN (REP. LAPUS). Can we ask the DOF to respond to those before we call
Congressman Teves?

MR. PURISIMA. Thank you, Mr. Chair.

Yes, from definitely improving the collection, it will help us because it will then enter as an
official revenue although when dividends declare it also goes in as other income. (sic)

xxxx

REP. TEVES. Mr. Chairman.

xxxx

THE CHAIRMAN (REP. LAPUS). Congressman Teves.

REP. TEVES. Yeah. Pagcor is controlled under Section 27, that is on income tax. Now, we
are talking here on value-added tax. Do you mean to say we are going to amend it from
income tax to value-added tax, as far as Pagcor is concerned?
THE CHAIRMAN (SEN. RECTO). No. We are just amending that section with regard to the
exemption from income tax of Pagcor.

xxxx

REP. NOGRALES. Mr. Chairman, Mr. Chairman. Mr. Chairman.

THE CHAIRMAN (REP. LAPUS). Congressman Nograles.

REP. NOGRALES. Just a point of inquiry from the Chair. What exactly are the functions of
Pagcor that are VATable? What will we VAT in Pagcor?

THE CHAIRMAN (REP. LAPUS). This is on own income tax. This is Pagcor income tax.

REP. NOGRALES. No, that's why. Anong i-va-Vat natin sa kanya. Sale of what?

xxxx

REP. VILLAFUERTE. Mr. Chairman, my question is, what are we VATing Pagcor with, is it the .
..

REP. NOGRALES. Mr. Chairman, this is a secret agreement or the way they craft their contract,
which basis?

THE CHAIRMAN (SEN. RECTO). Congressman Nograles, the Senate version does not
discuss a VAT on Pagcor but it just takes away their exemption from non-payment of
income tax.22

Taxation is the rule and exemption is the exception.23 The burden of proof rests upon the party
claiming exemption to prove that it is, in fact, covered by the exemption so claimed.24 As a rule,
tax exemptions are construed strongly against the claimant.25 Exemptions must be shown to exist
clearly and categorically, and supported by clear legal provision.26

In this case, PAGCOR failed to prove that it is still exempt from the payment of corporate
income tax, considering that Section 1 of R.A. No. 9337 amended Section 27 (c) of the National
Internal Revenue Code of 1997 by omitting PAGCOR from the exemption. The legislative intent,
as shown by the discussions in the Bicameral Conference Meeting, is to require PAGCOR to pay
corporate income tax; hence, the omission or removal of PAGCOR from exemption from the
payment of corporate income tax. It is a basic precept of statutory construction that the express
mention of one person, thing, act, or consequence excludes all others as expressed in the familiar
maxim expressio unius est exclusio alterius.27 Thus, the express mention of the GOCCs
exempted from payment of corporate income tax excludes all others. Not being excepted,
petitioner PAGCOR must be regarded as coming within the purview of the general rule that
GOCCs shall pay corporate income tax, expressed in the maxim: exceptio firmat regulam in
casibus non exceptis.28
PAGCOR cannot find support in the equal protection clause of the Constitution, as the legislative
records of the Bicameral Conference Meeting dated October 27, 1997, of the Committee on
Ways and Means, show that PAGCOR’s exemption from payment of corporate income tax, as
provided in Section 27 (c) of R.A. No. 8424, or the National Internal Revenue Code of 1997, was
not made pursuant to a valid classification based on substantial distinctions and the other
requirements of a reasonable classification by legislative bodies, so that the law may operate
only on some, and not all, without violating the equal protection clause. The legislative records
show that the basis of the grant of exemption to PAGCOR from corporate income tax was
PAGCOR’s own request to be exempted.

Petitioner further contends that Section 1 (c) of R.A. No. 9337 is null and void ab initio for
violating the non-impairment clause of the Constitution. Petitioner avers that laws form part of,
and is read into, the contract even without the parties expressly saying so. Petitioner states that
the private parties/investors transacting with it considered the tax exemptions, which inure to
their benefit, as the main consideration and inducement for their decision to transact/invest with
it. Petitioner argues that the withdrawal of its exemption from corporate income tax by R.A. No.
9337 has the effect of changing the main consideration and inducement for the transactions of
private parties with it; thus, the amendatory provision is violative of the non-impairment clause
of the Constitution.

Petitioner’s contention lacks merit.

The non-impairment clause is contained in Section 10, Article III of the Constitution, which
provides that no law impairing the obligation of contracts shall be passed. The non-impairment
clause is limited in application to laws that derogate from prior acts or contracts by enlarging,
abridging or in any manner changing the intention of the parties.29 There is impairment if a
subsequent law changes the terms of a contract between the parties, imposes new conditions,
dispenses with those agreed upon or withdraws remedies for the enforcement of the rights of the
parties.30

As regards franchises, Section 11, Article XII of the Constitution31 provides that no franchise or
right shall be granted except under the condition that it shall be subject to amendment, alteration,
or repeal by the Congress when the common good so requires.32

In Manila Electric Company v. Province of Laguna,33 the Court held that a franchise partakes the
nature of a grant, which is beyond the purview of the non-impairment clause of the
Constitution.34 The pertinent portion of the case states:

While the Court has, not too infrequently, referred to tax exemptions contained in special
franchises as being in the nature of contracts and a part of the inducement for carrying on the
franchise, these exemptions, nevertheless, are far from being strictly contractual in nature.
Contractual tax exemptions, in the real sense of the term and where the non-impairment clause of
the Constitution can rightly be invoked, are those agreed to by the taxing authority in contracts,
such as those contained in government bonds or debentures, lawfully entered into by them under
enabling laws in which the government, acting in its private capacity, sheds its cloak of authority
and waives its governmental immunity. Truly, tax exemptions of this kind may not be revoked
without impairing the obligations of contracts. These contractual tax exemptions, however, are
not to be confused with tax exemptions granted under franchises. A franchise partakes the nature
of a grant which is beyond the purview of the non-impairment clause of the Constitution. Indeed,
Article XII, Section 11, of the 1987 Constitution, like its precursor provisions in the 1935 and the
1973 Constitutions, is explicit that no franchise for the operation of a public utility shall be
granted except under the condition that such privilege shall be subject to amendment, alteration
or repeal by Congress as and when the common good so requires.35

In this case, PAGCOR was granted a franchise to operate and maintain gambling casinos, clubs
and other recreation or amusement places, sports, gaming pools, i.e., basketball, football,
lotteries, etc., whether on land or sea, within the territorial jurisdiction of the Republic of the
Philippines.36 Under Section 11, Article XII of the Constitution, PAGCOR’s franchise is subject
to amendment, alteration or repeal by Congress such as the amendment under Section 1 of R.A.
No. 9377. Hence, the provision in Section 1 of R.A. No. 9337, amending Section 27 (c) of R.A.
No. 8424 by withdrawing the exemption of PAGCOR from corporate income tax, which may
affect any benefits to PAGCOR’s transactions with private parties, is not violative of the non-
impairment clause of the Constitution.

Anent the validity of RR No. 16-2005, the Court holds that the provision subjecting PAGCOR to
10% VAT is invalid for being contrary to R.A. No. 9337. Nowhere in R.A. No. 9337 is it
provided that petitioner can be subjected to VAT. R.A. No. 9337 is clear only as to the removal of
petitioner's exemption from the payment of corporate income tax, which was already addressed
above by this Court.

As pointed out by the OSG, R.A. No. 9337 itself exempts petitioner from VAT pursuant to
Section 7 (k) thereof, which reads:

Sec. 7. Section 109 of the same Code, as amended, is hereby further amended to read as follows:

Section 109. Exempt Transactions. - (1) Subject to the provisions of Subsection (2) hereof, the
following transactions shall be exempt from the value-added tax:

xxxx

(k) Transactions which are exempt under international agreements to which the Philippines is a
signatory or under special laws, except Presidential Decree No. 529.37

Petitioner is exempt from the payment of VAT, because PAGCOR’s charter, P.D. No. 1869, is a
special law that grants petitioner exemption from taxes.

Moreover, the exemption of PAGCOR from VAT is supported by Section 6 of R.A. No. 9337,
which retained Section 108 (B) (3) of R.A. No. 8424, thus:

[R.A. No. 9337], SEC. 6. Section 108 of the same Code (R.A. No. 8424), as amended, is hereby
further amended to read as follows:
SEC. 108. Value-Added Tax on Sale of Services and Use or Lease of Properties. —

(A) Rate and Base of Tax. — There shall be levied, assessed and collected, a value-added tax
equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services,
including the use or lease of properties: x x x

xxxx

(B) Transactions Subject to Zero Percent (0%) Rate. — The following services performed in the
Philippines by VAT-registered persons shall be subject to zero percent (0%) rate;

xxxx

(3) Services rendered to persons or entities whose exemption under special laws or international
agreements to which the Philippines is a signatory effectively subjects the supply of such
services to zero percent (0%) rate;

x x x x38

As pointed out by petitioner, although R.A. No. 9337 introduced amendments to Section 108 of
R.A. No. 8424 by imposing VAT on other services not previously covered, it did not amend the
portion of Section 108 (B) (3) that subjects to zero percent rate services performed by VAT-
registered persons to persons or entities whose exemption under special laws or international
agreements to which the Philippines is a signatory effectively subjects the supply of such
services to 0% rate.

Petitioner's exemption from VAT under Section 108 (B) (3) of R.A. No. 8424 has been
thoroughly and extensively discussed in Commissioner of Internal Revenue v. Acesite
(Philippines) Hotel Corporation.39 Acesite was the owner and operator of the Holiday Inn Manila
Pavilion Hotel. It leased a portion of the hotel’s premises to PAGCOR. It incurred VAT
amounting to ₱30,152,892.02 from its rental income and sale of food and beverages to PAGCOR
from January 1996 to April 1997. Acesite tried to shift the said taxes to PAGCOR by
incorporating it in the amount assessed to PAGCOR. However, PAGCOR refused to pay the
taxes because of its tax-exempt status. PAGCOR paid only the amount due to Acesite minus VAT
in the sum of ₱30,152,892.02. Acesite paid VAT in the amount of ₱30,152,892.02 to the
Commissioner of Internal Revenue, fearing the legal consequences of its non-payment. In May
1998, Acesite sought the refund of the amount it paid as VAT on the ground that its transaction
with PAGCOR was subject to zero rate as it was rendered to a tax-exempt entity. The Court ruled
that PAGCOR and Acesite were both exempt from paying VAT, thus:

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PAGCOR is exempt from payment of indirect taxes

It is undisputed that P.D. 1869, the charter creating PAGCOR, grants the latter an exemption
from the payment of taxes. Section 13 of P.D. 1869 pertinently provides:
Sec. 13. Exemptions. —

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(2) Income and other taxes. - (a) Franchise Holder: No tax of any kind or form, income or
otherwise, as well as fees, charges or levies of whatever nature, whether National or Local, shall
be assessed and collected under this Franchise from the Corporation; nor shall any form of tax or
charge attach in any way to the earnings of the Corporation, except a Franchise Tax of five (5%)
percent of the gross revenue or earnings derived by the Corporation from its operation under this
Franchise. Such tax shall be due and payable quarterly to the National Government and shall be
in lieu of all kinds of taxes, levies, fees or assessments of any kind, nature or description, levied,
established or collected by any municipal, provincial, or national government authority.

(b) Others: The exemptions herein granted for earnings derived from the operations conducted
under the franchise specifically from the payment of any tax, income or otherwise, as well as any
form of charges, fees or levies, shall inure to the benefit of and extend to corporation(s),
association(s), agency(ies), or individual(s) with whom the Corporation or operator has any
contractual relationship in connection with the operations of the casino(s) authorized to be
conducted under this Franchise and to those receiving compensation or other remuneration from
the Corporation or operator as a result of essential facilities furnished and/or technical services
rendered to the Corporation or operator.

Petitioner contends that the above tax exemption refers only to PAGCOR's direct tax liability and
not to indirect taxes, like the VAT.

We disagree.

A close scrutiny of the above provisos clearly gives PAGCOR a blanket exemption to taxes with
no distinction on whether the taxes are direct or indirect. We are one with the CA ruling that
PAGCOR is also exempt from indirect taxes, like VAT, as follows:

Under the above provision [Section 13 (2) (b) of P.D. 1869], the term "Corporation" or operator
refers to PAGCOR. Although the law does not specifically mention PAGCOR's exemption from
indirect taxes, PAGCOR is undoubtedly exempt from such taxes because the law exempts from
taxes persons or entities contracting with PAGCOR in casino operations. Although, differently
worded, the provision clearly exempts PAGCOR from indirect taxes. In fact, it goes one step
further by granting tax exempt status to persons dealing with PAGCOR in casino operations. The
unmistakable conclusion is that PAGCOR is not liable for the P30, 152,892.02 VAT and neither
is Acesite as the latter is effectively subject to zero percent rate under Sec. 108 B (3), R.A. 8424.
(Emphasis supplied.)

Indeed, by extending the exemption to entities or individuals dealing with PAGCOR, the
legislature clearly granted exemption also from indirect taxes. It must be noted that the indirect
tax of VAT, as in the instant case, can be shifted or passed to the buyer, transferee, or lessee of the
goods, properties, or services subject to VAT. Thus, by extending the tax exemption to entities
or individuals dealing with PAGCOR in casino operations, it is exempting PAGCOR from
being liable to indirect taxes.

The manner of charging VAT does not make PAGCOR liable to said tax.

It is true that VAT can either be incorporated in the value of the goods, properties, or services
sold or leased, in which case it is computed as 1/11 of such value, or charged as an additional
10% to the value. Verily, the seller or lessor has the option to follow either way in charging its
clients and customer. In the instant case, Acesite followed the latter method, that is, charging an
additional 10% of the gross sales and rentals. Be that as it may, the use of either method, and in
particular, the first method, does not denigrate the fact that PAGCOR is exempt from an indirect
tax, like VAT.

VAT exemption extends to Acesite

Thus, while it was proper for PAGCOR not to pay the 10% VAT charged by Acesite, the latter is
not liable for the payment of it as it is exempt in this particular transaction by operation of law to
pay the indirect tax. Such exemption falls within the former Section 102 (b) (3) of the 1977 Tax
Code, as amended (now Sec. 108 [b] [3] of R.A. 8424), which provides:

Section 102. Value-added tax on sale of services.- (a) Rate and base of tax - There shall be
levied, assessed and collected, a value-added tax equivalent to 10% of gross receipts derived by
any person engaged in the sale of services x x x; Provided, that the following services performed
in the Philippines by VAT registered persons shall be subject to 0%.

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(3) Services rendered to persons or entities whose exemption under special laws or international
agreements to which the Philippines is a signatory effectively subjects the supply of such
services to zero (0%) rate (emphasis supplied).

The rationale for the exemption from indirect taxes provided for in P.D. 1869 and the extension
of such exemption to entities or individuals dealing with PAGCOR in casino operations are best
elucidated from the 1987 case of Commissioner of Internal Revenue v. John Gotamco & Sons,
Inc., where the absolute tax exemption of the World Health Organization (WHO) upon an
international agreement was upheld. We held in said case that the exemption of contractee WHO
should be implemented to mean that the entity or person exempt is the contractor itself who
constructed the building owned by contractee WHO, and such does not violate the rule that tax
exemptions are personal because the manifest intention of the agreement is to exempt the
contractor so that no contractor's tax may be shifted to the contractee WHO. Thus, the proviso in
P.D. 1869, extending the exemption to entities or individuals dealing with PAGCOR in casino
operations, is clearly to proscribe any indirect tax, like VAT, that may be shifted to PAGCOR.40

Although the basis of the exemption of PAGCOR and Acesite from VAT in the case of The
Commissioner of Internal Revenue v. Acesite (Philippines) Hotel Corporation was Section 102
(b) of the 1977 Tax Code, as amended, which section was retained as Section 108 (B) (3) in R.A.
No. 8424,41 it is still applicable to this case, since the provision relied upon has been retained in
R.A. No. 9337.421avvphi1

It is settled rule that in case of discrepancy between the basic law and a rule or regulation issued
to implement said law, the basic law prevails, because the said rule or regulation cannot go
beyond the terms and provisions of the basic law.43 RR No. 16-2005, therefore, cannot go beyond
the provisions of R.A. No. 9337. Since PAGCOR is exempt from VAT under R.A. No. 9337, the
BIR exceeded its authority in subjecting PAGCOR to 10% VAT under RR No. 16-2005; hence,
the said regulatory provision is hereby nullified.

WHEREFORE, the petition is PARTLY GRANTED. Section 1 of Republic Act No. 9337,
amending Section 27 (c) of the National Internal Revenue Code of 1997, by excluding petitioner
Philippine Amusement and Gaming Corporation from the enumeration of government-owned
and controlled corporations exempted from corporate income tax is valid and constitutional,
while BIR Revenue Regulations No. 16-2005 insofar as it subjects PAGCOR to 10% VAT is null
and void for being contrary to the National Internal Revenue Code of 1997, as amended by
Republic Act No. 9337.

No costs.