CIR V.

BOAC (TAX)

British Overseas Airways Corp (BOAC) is a 100% British Government-owned corporation engaged in
international airline business and is a member of the Interline Air Transport Association, and thus, it
operates air transportation services and sells transportation tickets over the routes of the other airline
members.

From 1959 to 1972, BOAC had no landing rights for traffic purposes in the Philippines and thus, did not
carry passengers and/or cargo to or from the Philippines but maintained a general sales agent in the
Philippines - Warner Barnes & Co. Ltd. and later, Qantas Airways - which was responsible for selling
BOAC tickets covering passengers and cargoes. The Commissioner of Internal Revenue assessed
deficiency income taxes against BOAC.

Issue: Whether the revenue derived by BOAC from ticket sales in the Philippines, constitute income of
BOAC from Philippine sources, and accordingly taxable.

The source of an income is the property, activity, or service that produced the income. 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. Herein, the sale of tickets in the Philippines is the activity that
produced the income. the tickets exchanged hands here and payment for fares were also made here in
the Philippine currency.

The situs 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. PD 68, in relation to PD 1355, ensures that international airlines are taxed on their
income from Philippine sources. The 2 1/2% tax on gross billings is an income tax. If it had been
intended as an excise tax or percentage tax, it would have been placed under Title V of the Tax Code
covering taxes on business.

MADRIGAL V. RAFFERTY,38PHIL.414(1918)

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to the Civil
Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The marriage was
contracted under the provisions of law concerning conjugal partnerships (sociedad de gananciales). On
February 25, 1915, Vicente Madrigal filed sworn declaration on the prescribed form with the Collector of
Internal Revenue, showing, as his total net income for the year 1914, the sum of P296,302.73. Subsequently
Madrigal submitted the claim that the said P296,302.73 did not represent his income for the year 1914, but
was in fact the income of the conjugal partnership existing between himself and his wife Susana Paterno, and
that in computing and assessing the additional income tax provided by the Act of Congress of October 3,
1913, the income declared by Vicente Madrigal should be divided into two equal parts, one-half to be
considered the income of Vicente Madrigal and the other half of Susana Paterno. The general question had in
the meantime been submitted to the Attorney-General of the Philippine Islands who in an opinion dated
March 17, 1915, held with the petitioner Madrigal. The revenue officers being still unsatisfied, the
correspondence together with this opinion was forwarded to Washington for a decision by the United States
Treasury Department. The United States Commissioner of Internal Revenue reversed the opinion of the
Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely by the Collector of
Internal Revenue, action was begun by Vicente Madrigal and his wife Susana Paterno in the Court of First
Instance of the city of Manila against Collector of Internal Revenue and the Deputy Collector of Internal
Revenue for the recovery of the sum of P3,786.08, alleged to have been wrongfully and illegally collected by
the defendants from the plaintiff, Vicente Madrigal, under the provisions of the Act of Congress known as the
Income Tax Law. The burden of the complaint was that if the income tax for the year 1914 had been correctly
and lawfully computed there would have been due payable by each of the plaintiffs the sum of P2,921.09,
which taken together amounts of a total of P5,842.18 instead of P9,668.21, erroneously and unlawfully
collected from the plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid as income tax for
the year 1914, P3,786.08, in excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and the
stipulation, sets forth the basis of defendants’ stand in the following way: The income of Vicente Madrigal and
his wife Susana Paterno of the year 1914 was made up of three items: (1) P362,407.67, the profits made by
Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits made by Susana Paterno in her
embroidery business; (3) P16,687.80, the profits made by Vicente Madrigal in a pawnshop company. The sum
of these three items is P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the year
1914. General deductions were claimed and allowed in the sum of P86,879.24. The resulting net income was
P296,302.73. For the purpose of assessing the normal tax of one per cent on the net income there were
allowed as specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at source,
and (2) P8,000, the specific exemption granted to Vicente Madrigal and Susana Paterno, husband and wife.
The remainder, P271,614.93 was the sum upon which the normal tax of one per cent was assessed. The
normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in the
Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income tax, is that is
should be divided into two equal parts, because of the conjugal partnership existing between them. The
learned argument of counsel is mostly based upon the provisions of the Civil Code establishing the sociedad
de gananciales. The counter contentions of appellees are that the taxes imposed by the Income Tax Law are
as the name implies taxes upon income tax and not upon capital and property; that the fact that Madrigal
was a married man, and his marriage contracted under the provisions governing the conjugal partnership,
has no bearing on income considered as income, and that the distinction must be drawn between the
ordinary form of commercial partnership and the conjugal partnership of spouses resulting from the relation
of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been given the course of
history. The final stage has been the selection of income as the norm of taxation. (See Seligman, “The Income
Tax,” Introduction.) The Income Tax Law of the United States, extended to the Philippine Islands, is the result
of an effect on the part of the legislators to put into statutory form this canon of taxation and of social reform.
The aim has been to mitigate the evils arising from inequalities of wealth by a progressive scheme of
taxation, which places the burden on those best able to pay. To carry out this idea, public considerations have
demanded an exemption roughly equivalent to the minimum of subsistence. With these exceptions, the
income tax is supposed to reach the earnings of the entire non-governmental property of the country. Such is
the background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference between capital and
income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is called
capital. A flow of services rendered by that capital by the payment of money from it or any other benefit
rendered by a fund of capital in relation to such fund through a period of time is called an income. Capital is
wealth, while income is the service of wealth. (See Fisher, “The Nature of Capital and Income.”) The Supreme
Court of Georgia expresses the thought in the following figurative language: “The fact is that property is a
tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit.” (Waring vs. City of
Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on property. “Income,” as here used, can be
defined as “profits or gains.” (London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N.
S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster’s Income Tax, second edition
[1915], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890],
136 U.S., 549; and Towne vs. Eisner, decided by the United States Supreme Court, January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband and wife not living
apart, contains the following:

The husband, as the head and legal representative of the household and general custodian of its income,
should make and render the return of the aggregate income of himself and wife, and for the purpose of
levying the income tax it is assumed that he can ascertain the total amount of said income. If a wife has a
separate estate managed by herself as her own separate property, and receives an income of more than
$3,000, she may make return of her own income, and if the husband has other net income, making the
aggregate of both incomes more than $4,000, the wife’s return should be attached to the return of her
husband, or his income should be included in her return, in order that a deduction of $4,000 may be made
from the aggregate of both incomes. The tax in such case, however, will be imposed only upon so much of
the aggregate income of both shall exceed $4,000. If either husband or wife separately has an income equal
to or in excess of $3,000, a return of annual net income is required under the law, and such return must
include the income of both, and in such case the return must be made even though the combined income of
both be less than $4,000. If the aggregate net income of both exceeds $4,000, an annual return of their
combined incomes must be made in the manner stated, although neither one separately has an income of
$3,000 per annum. They are jointly and separately liable for such return and for the payment of the tax. The
single or married status of the person claiming the specific exemption shall be determined as one of the time
of claiming such exemption which return is made, otherwise the status at the close of the year.”

With these general observations relative to the Income Tax Law in force in the Philippine Islands, we turn for a
moment to consider the provisions of the Civil Code dealing with the conjugal partnership. Recently in two
elaborate decisions in which a long line of Spanish authorities were cited, this court in speaking of the
conjugal partnership, decided that “prior to the liquidation the interest of the wife and in case of her death, of
her heirs, is an interest inchoate, a mere expectancy, which constitutes neither a legal nor an equitable
estate, and does not ripen into title until there appears that there are assets in the community as a result of
the liquidation and settlement.” (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and Laxamana
vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband Vicente
Madrigal during the life of the conjugal partnership. She has an interest in the ultimate property rights and in
the ultimate ownership of property acquired as income after such income has become capital. Susana
Paterno has no absolute right to one-half the income of the conjugal partnership. Not being seized of a
separate estate, Susana Paterno cannot make a separate return in order to receive the benefit of the
exemption which would arise by reason of the additional tax. As she has no estate and income, actually and
legally vested in her and entirely distinct from her husband’s property, the income cannot properly be
considered the separate income of the wife for the purposes of the additional tax. Moreover, the Income Tax
Law does not look on the spouses as individual partners in an ordinary partnership. The husband and wife are
only entitled to the exemption of P8,000 specifically granted by the law. The higher schedules of the
additional tax directed at the incomes of the wealthy may not be partially defeated by reliance on provisions
in our Civil Code dealing with the conjugal partnership and having no application to the Income Tax Law. The
aims and purposes of the Income Tax Law must be given effect.
The point we are discussing has heretofore been considered by the Attorney-General of the Philippine Islands
and the United States Treasury Department. The decision of the latter overruling the opinion of the Attorney-
General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,

Chief, Bureau of Insular Affairs, War Department,

Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of correspondence “from the
Philippine authorities relative to the method of submission of income tax returns by marred person.”

You advise that “The Governor-General, in forwarding the papers to the Bureau, advises that the Insular
Auditor has been authorized to suspend action on the warrants in question until an authoritative decision on
the points raised can be secured from the Treasury Department.”

From the correspondence it appears that Gregorio Araneta, married and living with his wife, had an income of
an amount sufficient to require the imposition of the net income was properly computed and then both
income and deductions and the specific exemption were divided in half and two returns made, one return for
each half in the names respectively of the husband and wife, so that under the returns as filed there would be
an escape from the additional tax; that Araneta claims the returns are correct on the ground under the
Philippine law his wife is entitled to half of his earnings; that Araneta has dominion over the income and
under the Philippine law, the right to determine its use and disposition; that in this case the wife has no
“separate estate” within the contemplation of the Act of October 3, 1913, levying an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax was assessed against
the entire net income against Gregorio Araneta; that the tax was paid and an application for refund made,
and that the application for refund was rejected, whereupon the matter was submitted to the Attorney-
General of the Islands who holds that the returns were correctly rendered, and that the refund should be
allowed; and thereupon the question at issue is submitted through the Governor-General of the Islands and
Bureau of Insular Affairs for the advisory opinion of this office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be administered as in
the United States but by the appropriate internal-revenue officers of the Philippine Government. You are
therefore advised that upon the facts as stated, this office holds that for the Federal Income Tax (Act of
October 3, 1913), the entire net income in this case was taxable to Gregorio Araneta, both for the normal and
additional tax, and that the application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax Law is that which
belongs to her solely and separate and apart from her husband, and over which her husband has no right in
equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that each person of lawful age
(not excused from so doing) having a net income of $3,000 or over for the taxable year shall make a return
showing the facts; that from the net income so shown there shall be deducted $3,000 where the person
making the return is a single person, or married and not living with consort, and $1,000 additional where the
person making the return is married and living with consort; but that where the husband and wife both make
returns (they living together), the amount of deduction from the aggregate of their several incomes shall not
exceed $4,000.
The only occasion for a wife making a return is where she has income from a sole and separate estate in
excess of $3,000, but together they have an income in excess of $4,000, in which the latter event either the
husband or wife may make the return but not both. In all instances the income of husband and wife whether
from separate estates or not, is taken as a whole for the purpose of the normal tax. Where the wife has
income from a separate estate makes return made by her husband, while the incomes are added together for
the purpose of the normal tax they are taken separately for the purpose of the additional tax. In this case,
however, the wife has no separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.

Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax Law was
drafted by the Congress of the United States and has been by the Congress extended to the Philippine
Islands. Being thus a law of American origin and being peculiarly intricate in its provisions, the authoritative
decision of the official who is charged with enforcing it has peculiar force for the Philippines. It has come to be
a well-settled rule that great weight should be given to the construction placed upon a revenue law, whose
meaning is doubtful, by the department charged with its execution. (U.S. vs. Cerecedo Hermanos y Cia.
[1907], 209 U.S., 338; In re Allen [1903], 2 Phil., 630; Government of the Philippine Islands vs. Municipality of
Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.) We conclude that the
judgment should be as it is hereby affirmed with costs against appellants. So ordered.

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

The essential difference between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money
from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called
income. Capital is wealth, while income is the service of wealth.

FACTS:
• Vicente Madrigal and Susana Paterno were legally married prior to Januray 1, 1914. The marriage was contracted
under the provisions of law concerning conjugal partnership
• On 1915, Madrigal filed a declaration of his net income for year 1914, the sum of P296,302.73
• Vicente Madrigal was contending that the said declared income does not represent his income for the year 1914 as it
was the income of his conjugal partnership with Paterno. He said that in computing for his additional income tax, the
amount declared should be divided by 2.
• The revenue officer was not satisfied with Madrigal’s explanation and ultimately, the United States Commissioner of
Internal Revenue decided against the claim of Madrigal.
• Madrigal paid under protest, and the couple decided to recover the sum of P3,786.08 alleged to have been
wrongfully and illegally assessed and collected by the CIR.
ISSUE: Whether or not the income reported by Madrigal on 1915 should
be divided into 2 in computing for the additional income tax.

HELD:
• No! The point of view of the CIR is that the Income Tax Law, as the name implies, taxes upon income and not upon
capital and property.
• The essential difference between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money from
it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called income.
Capital is wealth, while income is the service of wealth.
• As Paterno has no estate and income, actually and legally vested in her and entirely distinct from her husband’s
property, the income cannot properly be considered the separate income of the wife for the purposes of the additional
tax.
• To recapitulate, Vicente wants to half his declared income in computing for his tax since he is arguing that he has a
conjugal partnership with his wife. However, the court ruled that the one that should be taxed is the income which is
the flow of the capital, thus it should not be divided into 2.

LIMPAN INVESTMENT VS. CIR

Actual vs Constructive Receipt

Limpan Investment Company deemed to have constructively received rental payments in 1957 when they were
deposited in court due to its refusal to receive them.

FACTS:
• BIR assessed deficiency taxes on Limpan Corp, a company that leases real property, for under-declaring its rental
income for years 1956-57 by around P20K and P81K respectively.
• Petitioner appeals on the ground that portions of these underdeclared rents are yet to be collected by the previous
owners and turned over or received by the corporation.
• Petitioner cited that some rents were deposited with the court, such that the corporation does not have actual nor
constructive control over them.
• The sole witness for the petitioner, Solis (Corporate Secretary- Treasurer) admitted to some undeclared rents in 1956
and1957, and that some balances were not collected by the corporation in 1956 because the lessees refused to
recognize and pay rent to the new owners and that the corp’s president Isabelo Lim collected some rent and reported
it in his personal income statement, but did not turn over the rent to the corporation.
• He also cites lack of actual or constructive control over rents deposited with the court.
ISSUE:
Whether or not the BIR was correct in assessing deficiency taxes against Limpan Corp. for undeclared rental income

HELD:
Yes. Petitioner admitted that it indeed had undeclared income (although only a part and not the full amount assessed
by BIR). Thus, it has become incumbent upon them to prove their excuses by clear and convincing evidence, which it
has failed to do. When is there constructive receipt of rent? With regard to 1957 rents deposited with the court, and
withdrawn only in 1958, the court viewed the corporation as having constructively received said rents. The non-
collection was the petitioner’s fault since it refused to refused to accept the rent, and not due to nonpayment of
lessees. Hence, although the corporation did not actually receive the rent, it is deemed to have constructively received
them.

CIR v Japan Airlines (JAL)

(Situs of Taxation)

Facts:

JAL is a foreign corporation engaged in the business of International air carriage. Since mid-July of 1957, JAL
hadmaintained an office at the Filipinas Hotel, Roxas BoulevardManila. The said office did not sell tickets but
was merely for the promotion of the company. On July 17 1957, JALconstituted PAL as its agent in the
Philippines. PAL sold ticketsfor and in behalf of JAL.On June 1972, JAL then received deficiency income
taxassessments notices and a demand letter from petitioner for years 1959 through 1963. JAL protested against
saidassessments alleging that as a non-resident foreigncorporation, it as taxable only on income from
Philippinessources as determined by section 37 of the Tax Code, therebeing no income on said years, JAL is not
liable for taxes.

Issue:
WON proceeds from sales of JAL tickets sold in thePhilippines are taxable as income from sources within
thePhilippines

.Held:

The ticket sales are taxable.

Citing the case of CIR v BOAC, the court reiterated that thesource of an income is the property, activity or
service thatproduced the income. For the source of income to beconsidered as coming from the Philippines, it is
sufficient thatthe income is derived from activity within the Philippines.The absence of flight operations to and
from the Philippines isnot determinative of the source of income or the situs of income taxation. The test of
taxability is the source, and thesource of the income is that activity which produced theincome. In this case, as
JAL constitutes PAL as its agent, thesales of JAL tickets made by PAL is taxable.