Difference between Capital and Income
Attorney-General, and thus decided against the claim of Madrigal.
G.R. No. L-12287 August 7, 1918
VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,
vs.
JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO
CONCEPCION, Deputy Collector of Internal Revenue, defendants-appellees.
Gregorio Araneta for appellants.
Assistant Attorney Round for appellees.
MALCOLM, J.:
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
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.
Test in determining Income/ Doctrines on determination of Taxable
Income
Realization Test/ Severance Theory
Eisner vs Macomber
Mrs. Macomber owned 2,200 shares in Standard Oil. Standard Oil declared a
50% stock dividend and she received 1,100 additional shares, of which about
$20,000 in par value represented earnings accumulated by the company
recapitalized rather than distributedsince the effective date of the original tax
law.
The current statute expressly included stock dividends in income, and the
government contended that those certificates should be taxed as income to
Mrs. Macomber as though the corporation had distributed money to her. Mrs.
Macomber sued Mr. Mark Eisner, the Collector of Internal Revenue, for a
refund.
Economic substance of a stock dividend[edit]
The stock dividend in this case was the economic equivalent of a stock split
a transaction in which the corporation multiplies the total number of shares
outstanding, but gives the new shares to shareholders in proportion to the
number they previously held. For example, if a corporation declares a "two for
one" stock split (and distributes no money or other property to any
stockholder), a stockholder who held 100 shares at $4 per share will now hold
200 shares with a value of $2 each, which is still $400 in value.
Stock dividends vs. cash dividends[edit]
A shareholder's assets do not grow after this sort of stock dividend.
Metaphorically, the "pie" is still the same sizebut it has been sliced into more
pieces, each piece being proportionately smaller. Of course, the same is true
of a cash dividend: the shareholder gains cash, but the corporation
represented by his shares has also lost cash, so that these shares implicitly
decline in value by an equal amount.
A shareholder also makes no "sale or other disposition" of stock after this sort
of stock dividend. The taxpayer still owns the same proportionate percentage
of the corporation he or she owned prior to the stock dividend. Again, this is
also true of a cash dividend.
However, several important factors distinguish a stock and cash dividend.
"Overall, the aim of the tax law is to impose a tax on "dividends" when assets
representing corporate earnings are transferred to the shareholders. Stock
dividends, however, merely give the shareholders additional pieces of paper to
represent the same equitable interest; they do not transfer assets or create
new priorities among the security-holders. The total value of the common
shares, though now spread out over a larger number of units, is left
unchanged from its previous level. In effect, nothing of substance has
occurred."[2]
Issue[edit]
Essentially, therefore, [i.e. in light of the fact that stock and cash dividends are
economically equivalent,] the question in Macomber was not whether the
shareholder had gain in an economic sense, but whether in legal or
accounting terms the stock dividend was to be regarded as a taxable event. ...
Stripped of its Constitutional element, the issue in Eisner v. Macomber in the
end comes down to a "battle of similarities." Is a stock dividend (as the
majority held) "more like" a situation in which a corporation simply
accumulates its earnings and makes no distribution at all? Or is it (as Brandeis
thought) "more like" the receipt of a cash dividend which is followed by a
reinvestment of the cash received in additional shares?
Marvin Chirelstein, Federal Income Taxation, A Law Student's Guide [3]
Decision of the Supreme Court[edit]
In the majority opinion, Justice Mahlon Pitney ruled that this stock dividend
was not a realization of income by the taxpayer-shareholder for purposes of
the Sixteenth Amendment:
We are clear that not only does a stock dividend really take nothing
from the property of the corporation and add nothing to that of the
shareholder, but that the antecedent accumulation of profits evidenced
thereby, while indicating that the shareholder is richer because of an
increase of his capital, at the same time shows he has not realized or
received any income in the transaction.
The Court noted that in Towne v. Eisner, it had clearly stated that stock
dividends were not income, as nothing of value was received by Towne - the
company was not worth any less than it was when the dividend was declared,
and the total value of Towne's stock had not changed.
Although the Eisner v. Macomber Court acknowledged the power of the
Federal Government to tax income under the Sixteenth Amendment, the Court
essentially said this did not give Congress the power to tax as income
anything other than income, i.e., that Congress did not have the power to re-
define the term income as it appeared in the Constitution:
Throughout the argument of the Government, in a variety of forms,
runs the fundamental error already mentioneda failure to appraise
correctly the force of the term "income" as used in the Sixteenth
Amendment, or at least to give practical effect to it. Thus, the
Government contends that the tax "is levied on income derived from
corporate earnings," when in truth the stockholder has "derived"
nothing except paper certificates which, so far as they have any effect,
deny him [or "her" in this case, Mrs. Macomber] present
participation in such earnings. It [the government] contends that the tax
may be laid when earnings "are received by the stockholder," whereas
[s]he has received none; that the profits are "distributed by means of a
stock dividend," although a stock dividend distributes no profits; that
under the Act of 1916 "the tax is on the stockholder's share in
corporate earnings," when in truth a stockholder has no such share,
and receives none in a stock dividend; that "the profits are segregated
from his [her] former capital, and [s]he has a separate certificate
representing his [her] invested profits or gains," whereas there has
been no segregation of profits, nor has [s]he any separate certificate
representing a personal gain, since the certificates, new and old, are
alike in what they representa capital interest in the entire concerns of
the corporation.
The Court ordered that Macomber be refunded the tax she overpaid.
Claim of right Doctrine
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
TOURS SPECIALISTS, INC., and THE COURT OF TAX
APPEALS, respondents.
Gadioma Law Offices for private respondent.
This is a petition to review on certiorari the decision of the Court of Tax
Appeals which ruled that the money entrusted to private respondent Tours
Specialists, Inc., earmarked and paid for hotel room charges of tourists,
travelers and/or foreign travel agencies does not form part of its gross receipts
subject to the 3% independent contractor's tax under the National Internal
Revenue Code of 1977.
We adopt the findings of facts of the Court of Tax Appeals as follows:
For the years 1974 to 1976, petitioner (Tours Specialists, Inc.) had derived
income from its activities as a travel agency by servicing the needs of foreign
tourists and travelers and Filipino "Balikbayans" during their stay in this
country. Some of the services extended to the tourists consist of booking said
tourists and travelers in local hotels for their lodging and board needs;
transporting these foreign tourists from the airport to their respective hotels,
and from the latter to the airport upon their departure from the Philippines,
transporting them from their hotels to various embarkation points for local
tours, visits and excursions; securing permits for them to visit places of
interest; and arranging their cultural entertainment, shopping and recreational
activities.
In order to ably supply these services to the foreign tourists, petitioner and its
correspondent counterpart tourist agencies abroad have agreed to offer a
package fee for the tourists. Although the fee to be paid by said tourists is
quoted by the petitioner, the payments of the hotel room accommodations,
food and other personal expenses of said tourists, as a rule, are paid directly
either by tourists themselves, or by their foreign travel agencies to the local
hotels (pp. 77, t.s.n., February 2, 1981; Exhs. O & O-1, p. 29, CTA rec.; pp.
2425, t.s.n., ibid) and restaurants or shops, as the case may be.
It is also the case that some tour agencies abroad request the local tour
agencies, such as the petitioner in the case, that the hotel room charges, in
some specific cases, be paid through them. (Exh. Q, Q-1, p. 29 CTA rec., p.
25, T.s.n., ibid, pp. 5-6, 17-18, t.s.n., Aug. 20, 1981.; See also Exh. "U", pp. 22-
23, t.s.n., Oct. 9, 1981, pp. 3-4, 11., t.s.n., Aug. 10, 1982). By this
arrangement, the foreign tour agency entrusts to the petitioner Tours
Specialists, Inc., the fund for hotel room accommodation, which in turn is paid
by petitioner tour agency to the local hotel when billed. The procedure
observed is that the billing hotel sends the bill to the petitioner. The local hotel P 10,534.24
identifies the individual tourist, or the particular groups of tourists by code
name or group designation and also the duration of their stay for purposes of 14% interest computed by quarters
payment. Upon receipt of the bill, the petitioner then pays the local hotel with
the funds entrusted to it by the foreign tour correspondent agency. up to 12-28-79 6,808.47 P 17,342.71

Despite this arrangement, respondent Commissioner of Internal Revenue 1976 deficiency percentage
assessed petitioner for deficiency 3% contractor's tax as independent
contractor by including the entrusted hotel room charges in its gross receipts per investigation P 54,276.42
from services for the years 1974 to 1976. Consequently, on December 6,
1979, petitioner received from respondent the 3% deficiency independent 25% surcharge for late payment 13,569.11
contractor's tax assessment in the amount of P122,946.93 for the years 1974
to 1976, inclusive, computed as follows:

1974 deficiency percentage tax
P 67,845.53
per investigation P 3,995.63
14% interest computed by quarters
15% surcharge for late payment 998.91
up to 12-28-79 28,910.97 P 96,756.50

P 4,994.54
Total amount due P 122,946.93
=========
14% interest computed by quarters
In addition to the deficiency contractor's tax of P122,946.93, petitioner was
up to 12-28-79 3,953.18 P 8,847.72 assessed to pay a compromise penalty of P500.00.
1975 deficiency percentage tax Subsequently on December 11, 1979, petitioner formally protested the
assessment made by respondent on the ground that the money received and
per investigation P 8,427.39 entrusted to it by the tourists, earmarked to pay hotel room charges, were not
considered and have never been considered by it as part of its taxable gross
25% surcharge for late payment 2,106.85 receipts for purposes of computing and paying its constractor's tax.

During one of the hearings in this case, a witness, Serafina Sazon, Certified
Public Accountant and in charge of the Accounting Department of petitioner,
had testified, her credibility not having been destroyed on cross examination,
categorically stated that the amounts entrusted to it by the foreign tourist
agencies intended for payment of hotel room charges, were paid entirely to
the hotel concerned, without any portion thereof being diverted to its own
funds. (t.s.n., Feb. 2, 1981, pp. 7, 25; t.s.n., Aug. 20, 1981, pp. 5-9, 17-18).
The testimony of Serafina Sazon was corroborated by Gerardo Isada, General
Manager of petitioner, declaring to the effect that payments of hotel
accommodation are made through petitioner without any increase in the room
charged (t.s.n., Oct. 9, 1981, pp. 21-25) and that the reason why tourists pay
their room charge, or through their foreign tourists agencies, is the fact that the
room charge is exempt from hotel room tax under P.D. 31. (t.s.n., Ibid., pp. 25-
29.) Witness Isada stated, on cross-examination, that if their payment is made,
thru petitioner's tour agency, the hotel cost or charges "is only an act of
accomodation on our (its) part" or that the "agent abroad instead of sending
several telexes and saving on bank charges they take the option to send
money to us to be held in trust to be endorsed to the hotel." (pp. 3-4,
t.s.n. Aug. 10, 1982.)
Nevertheless, on June 2, 1980, respondent, without deciding the petitioner's
written protest, caused the issuance of a warrant of distraint and levy. (p. 51,
BIR Rec.) And later, respondent had petitioner's bank deposits garnished. (pp.
49-50, BIR Rec.)
Taking this action of respondent as the adverse and final decision on the
disputed assessment, petitioner appealed to this Court. (Rollo, pp. 40-45)
The petitioner raises the lone issue in this petition as follows:
WHETHER AMOUNTS RECEIVED BY A LOCAL TOURIST AND TRAVEL
AGENCY INCLUDED IN A PACKAGE FEE FROM TOURISTS OR FOREIGN
TOUR AGENCIES, INTENDED OR EARMARKED FOR HOTEL
ACCOMMODATIONS FORM PART OF GROSS RECEIPTS SUBJECT TO 3%
CONTRACTOR'S TAX. (Rollo, p. 23)
The petitioner premises the issue raised on the following assumptions:
Firstly, the ruling overlooks the fact that the amounts received, intended for
hotel room accommodations, were received as part of the package fee and,
therefore, form part of "gross receipts" as defined by law.
Secondly, there is no showing and is not established by the evidence. that the
amounts received and "earmarked" are actually what had been paid out as
hotel room charges. The mere possibility that the amounts actually paid could
be less than the amounts received is sufficient to destroy the validity of the
ruling. (Rollo, pp. 26-27)
In effect, the petitioner's lone issue is based on alleged error in the findings of
facts of the respondent court.
The well-settled doctrine is that the findings of facts of the Court of Tax
Appeals are binding on this Court and absent strong reasons for this Court to
delve into facts, only questions of law are open for determination. (Nilsen v.
Commissioner of Customs, 89 SCRA 43 [1979]; Balbas v. Domingo, 21 SCRA
444 [1967]; Raymundo v. De Joya, 101 SCRA 495 [1980]). In the recent case
of Sy Po v. Court of Appeals, (164 SCRA 524 [1988]), we ruled that the factual
findings of the Court of Tax Appeals are binding upon this court and can only
be disturbed on appeal if not supported by substantial evidence.
In the instant case, we find no reason to disregard and deviate from the
findings of facts of the Court of Tax Appeals.
As quoted earlier, the Court of Tax Appeals sufficiently explained the services
of a local travel agency, like the herein private respondent, rendered to foreign
customers. The respondent differentiated between the package fee offered
by both the local travel agency and its correspondent counterpart tourist
agencies abroad and the requests made by some tour agencies abroad to
local tour agencies wherein the hotel room charges in some specific cases,
would be paid to the local hotels through them. In the latter case, the
correspondent court found as a fact ". . . that the foreign tour agency entrusts
to the petitioner Tours Specialists, Inc. the fund for hotel room
accommodation, which in turn is paid by petitioner tour agency to the local =========
hotel when billed." (Rollo, p. 42) The following procedure is followed: The
billing hotel sends the bill to the respondent; the local hotel then identifies the Oct. 1976 P 71,134.80
individual tourist, or the particular group of tourist by code name or group
designation plus the duration of their stay for purposes of payment; upon Nov. 1976 409,019.17
receipt of the bill the private respondent pays the local hotel with the funds
entrusted to it by the foreign tour correspondent agency. Dec. 1976 142,761.55

Moreover, evidence presented by the private respondent shows that the

amounts entrusted to it by the foreign tourist agencies to pay the room
charges of foreign tourists in local hotels were not diverted to its funds; this 622,915.51
arrangement was only an act of accommodation on the part of the private
respondent. This evidence was not refuted.

In essence, the petitioner's assertion that the hotel room charges entrusted to
Grand Total P 904,995.29
the private respondent were part of the package fee paid by foreign tourists to
the respondent is not correct. The evidence is clear to the effect that the
amounts entrusted to the private respondent were exclusively for payment of =========
hotel room charges of foreign tourists entrusted to it by foreign travel
agencies. It is not true therefore, as stated by respondent, that there is no evidence
proving the amounts earmarked for hotel room charges. Since the BIR
As regards the petitioner's second assumption, the respondent court stated: examiners could not have manufactured the above figures representing
"advances for hotel room accommodations," these payments must have
certainly been taken from the records of petitioner, such as the invoices, hotel
. . . [C]ontrary to the contention of respondent, the records show, firstly, in the
bills, official receipts and other pertinent documents. (Rollo, pp. 48-49)
Examiners' Worksheet (Exh. T, p. 22, BIR Rec.), that from July to December
1976 alone, the following sums made up the hotel room accommodations:
The factual findings of the respondent court are supported by substantial
evidence, hence binding upon this Court.
July 1976 P 102,702.97
With these clarifications, the issue to be threshed out is as stated by the
Aug. 1976 121,167.19
respondent court, to wit:
Sept. 1976 53,209.61
. . . [W]hether or not the hotel room charges held in trust for foreign tourists
and travelers and/or correspondent foreign travel agencies and paid to local
host hotels form part of the taxable gross receipts for purposes of the 3%
contractor's tax. (Rollo, p. 45)
P 282,079.77
The petitioner opines that the gross receipts which are subject to the 3%
contractor's tax pursuant to Section 191 (Section 205 of the National Internal
Revenue Code of 1977) of the Tax Code include the entire gross receipts of a
taxpayer undiminished by any amount. According to the petitioner, this
interpretation is in consonance with B.I.R. Ruling No. 68-027, dated 23
October, 1968 (implementing Section 191 of the Tax Code) which states that
the 3% contractor's tax prescribed by Section 191 of the Tax Code is imposed
of the gross receipts of the contractor, "no deduction whatever being allowed
by said law." The petitioner contends that the only exception to this rule is
when there is a law or regulation which would exempt such gross receipts
from being subjected to the 3% contractor's tax citing the case
of Commissioner of Internal Revenue v. Manila Jockey Club, Inc. (108 Phil.
821 [1960]). Thus, the petitioner argues that since there is no law or regulation
that money entrusted, earmarked and paid for hotel room charges should not
form part of the gross receipts, then the said hotel room charges are included
in the private respondent's gross receipts for purposes of the 3% contractor's
tax.
In the case of Commissioner of Internal Revenue v. Manila Jockey Club, Inc.
(supra), the Commissioner appealed two decisions of the Court of Tax Appeals
disapproving his levy of amusement taxes upon the Manila Jockey Club, a
duly constituted corporation authorized to hold horse races in Manila. The
facts of the case show that the monies sought to be taxed never really
belonged to the club. The decision shows that during the period November
1946 to 1950, the Manila Jockey Club paid amusement tax on its commission
but without including the 5-1/2% which pursuant to Executive Order 320 and
Republic Act 309 went to the Board of Races, the owner of horses and
jockeys. Section 260 of the Internal Revenue Code provides that the
amusement tax was payable by the operator on its "gross receipts". The
Manila Jockey Club, however, did not consider as part of its "gross receipts"
subject to amusement tax the amounts which it had to deliver to the Board on
Races, the horse owners and the jockeys. This view was fully sustained by
three opinions of the Secretary of Justice, to wit:
There is no question that the Manila Jockey, Inc., owns only 7-1/2% of the
total bets registered by the Totalizer. This portion represents its share or
commission in the total amount of money it handles and goes to the funds
thereof as its own property which it may legally disburse for its own purposes.
The 5% does not belong to the club. It is merely held in trust for distribution as
prizes to the owners of winning horses. It is destined for no other object than
the payment of prizes and the club cannot otherwise appropriate this portion
without incurring liability to the owners of winning horses. It cannot be
considered as an item of expense because the sum used for the payment of
prizes is not taken from the funds of the club but from a certain portion of the
total bets especially earmarked for that purpose.
In view of all the foregoing, I am of the opinion that in the submission of the
returns for the amusement tax of 10% (now it is 20% of the "gross receipts",
provided for in Section 260 of the National Internal Revenue Code), the 5% of
the total bets that is set aside for prizes to owners of winning horses should
not be included by the Manila Jockey Club, Inc.
The Collector of the Internal Revenue, however had a different opinion on the
matter and demanded payment of amusement taxes. The Court of Tax
Appeals reversed the Collector.
We affirmed the decision of the Court of Tax Appeals and stated:
The Secretary's opinion was correct. The Government could not have meant
to tax as gross receipt of the Manila Jockey Club the 1/2% which it directs
same Club to turn over to the Board on Races. The latter being a Government
institution, there would be double taxation, which should be avoided unless the
statute admits of no other interpretation. In the same manner, the Government
could not have intended to consider as gross receipt the portion of the funds
which it directed the Club to give, or knew the Club would give, to winning
horses and jockeys admittedly 5%. It is true that the law says that out of the
total wager funds 12-1/2% shall be set aside as the "commission" of the race
track owner, but the law itself takes official notice, and actually approves or
directs payment of the portion that goes to owners of horses as prizes and
bonuses of jockeys, which portion is admittedly 5% out of that 12-1/2%
commission. As it did not at that time contemplate the application of "gross
receipts" revenue principle, the law in making a distribution of the total wager
funds, took no trouble of separating one item from the other; and for
convenience, grouped three items under one common denomination.
Needless to say, gross receipts of the proprietor of the amusement place
should not include any money which although delivered to the amusement
place has been especially earmarked by law or regulation for some person
other than the proprietor. (The situation thus differs from one in which the
owner of the amusement place, by a private contract, with its employees or
partners, agrees to reserve for them a portion of the proceeds of the
establishment. (See Wong & Lee v. Coll. 104 Phil. 469; 55 Off. Gaz. [51]
10539; Sy Chuico v. Coll., 107 Phil., 428; 59 Off. Gaz., [6] 896).
In the second case, the facts of the case are:
The Manila Jockey Club holds once a year a so called "special Novato race",
wherein only "novato" horses, (i.e. horses which are running for the first time
in an official [of the club] race), may take part. Owners of these horses must
pay to the Club an inscription fee of P1.00, and a declaration fee of P1.00 per
horse. In addition, each of them must contribute to a common fund (P10.00
per horse). The Club contributes an equal amount P10.00 per horse) to such
common fund, the total amount of which is added to the 5% participation of
horse owners already described herein-above in the first case.
Since the institution of this yearly special novato race in 1950, the Manila
Jockey Club never paid amusement tax on the moneys thus contributed by
horse owners (P10.00 each) because it entertained the belief that in
accordance with the three opinions of the Secretary of Justice herein-above
described, such contributions never formed part of its gross receipts. On the
inscription fee of the P1.00 per horse, it paid the tax. It did not on the
declaration fee of P1.00 because it was imposed by the Municipal Ordinance
of Manila and was turned over to the City officers.
The Collector of Internal Revenue required the Manila Jockey Club to pay
amusement tax on such contributed fund P10.00 per horse in the special
novato race, holding they were part of its gross receipts. The Manila Jockey
Club protested and resorted to the Court of Tax Appeals, where it obtained
favorable judgment on the same grounds sustained by said Court in
connection with the 5% of the total wager funds in the herein-mentioned first
case; they were not receipts of the Club.
We resolved the issue in the following manner:
We think the reasons for upholding the Tax Court's decision in the first case
apply to this one. The ten-peso contribution never belonged to the Club. It was
held by it as a trust fund. And then, after all, when it received the ten-peso
contribution, it at the same time contributed ten pesos out of its own pocket,
and thereafter distributed both amounts as prizes to horse owners. It would
seem unreasonable to regard the ten-peso contribution of the horse owners as
taxable receipt of the Club, since the latter, at the same moment it received
the contribution necessarily lost ten pesos too.
As demonstrated in the above-mentioned case, gross receipts subject to tax
under the Tax Code do not include monies or receipts entrusted to the
taxpayer which do not belong to them and do not redound to the taxpayer's
benefit; and it is not necessary that there must be a law or regulation which
would exempt such monies and receipts within the meaning of gross receipts
under the Tax Code.
Parenthetically, the room charges entrusted by the foreign travel agencies to
the private respondent do not form part of its gross receipts within the
definition of the Tax Code. The said receipts never belonged to the private
respondent. The private respondent never benefited from their payment to the
local hotels. As stated earlier, this arrangement was only to accommodate the
foreign travel agencies.
Another objection raised by the petitioner is to the respondent court's
application of Presidential Decree 31 which exempts foreign tourists from
payment of hotel room tax. Section 1 thereof provides:
Sec. 1. Foreign tourists and travelers shall be exempt from payment of any
and all hotel room tax for the entire period of their stay in the country.
The petitioner now alleges that P.D. 31 has no relevance to the case. He
contends that the tax under Section 191 of the Tax Code is in the nature of an
excise tax; that it is a tax on the exercise of the privilege to engage in business
as a contractor and that it is imposed on, and collectible from the person
exercising the privilege. He sums his arguments by stating that "while the
burden may be shifted to the person for whom the services are rendered by
the contractor, the latter is not relieved from payment of the tax." (Rollo, p. 28)
The same arguments were submitted by the Commissioner of Internal
Revenue in the case of Commissioner of Internal Revenue v. John Gotamco
& Son., Inc. (148 SCRA 36 [1987]), to justify his imposition of the 3%
contractor's tax under Section 191 of the National Internal Revenue Code on
the gross receipts John Gotamco & Sons, Inc., realized from the construction
of the World Health Organization (WHO) office building in Manila. We rejected
the petitioner's arguments and ruled:
We agree with the Court of Tax Appeals in rejecting this contention of the
petitioner. Said the respondent court:
"In context, direct taxes are those that are demanded from the very person
who, it is intended or desired, should pay them; while indirect taxes are those
that are demanded in the first instance from one person in the expectation and
intention that he can shift the burden to someone else. (Pollock v. Farmers, L
& T Co., 1957 US 429, 15 S. Ct. 673, 39 Law. ed. 759). The contractor's tax is
of course payable by the contractor but in the last analysis it is the owner of
the building that shoulders the burden of the tax because the same is shifted
by the contractor to the owner as a matter of self-preservation. Thus, it is an
indirect tax. And it is an indirect tax on the WHO because, although it is
payable by the petitioner, the latter can shift its burden on the WHO. In the last
analysis it is the WHO that will pay the tax indirectly through the contractor
and it certainly cannot be said that 'this tax has no bearing upon the World
Health Organization.'"
Petitioner claims that under the authority of the Philippine Acetylene Company
versus Commissioner of Internal Revenue, et al., (127 Phil. 461) the 3%
contractor's tax falls directly on Gotamco and cannot be shifted to the WHO.
The Court of Tax Appeals, however, held that the said case is not controlling in
this case, since the Host Agreement specifically exempts the WHO from
"indirect taxes." We agree. The Philippine Acetylene case involved a tax on
sales of goods which under the law had to be paid by the manufacturer or
producer; the fact that the manufacturer or producer might have added the
amount of the tax to the price of the goods did not make the sales tax "a tax
on the purchaser." The Court held that the sales tax must be paid by the
manufacturer or producer even if the sale is made to tax-exempt entities like
the National Power Corporation, an agency of the Philippine Government, and
to the Voice of America, an agency of the United States Government.
The Host Agreement, in specifically exempting the WHO from "indirect taxes,"
contemplates taxes which, although not imposed upon or paid by the
Organization directly, form part of the price paid or to be paid by it.
Accordingly, the significance of P.D. 31 is clearly established in determining
whether or not hotel room charges of foreign tourists in local hotels are subject
to the 3% contractor's tax. As the respondent court aptly stated:
. . . If the hotel room charges entrusted to petitioner will be subjected to 3%
contractor's tax as what respondent would want to do in this case, that would
in effect do indirectly what P.D. 31 would not like hotel room charges of foreign
tourists to be subjected to hotel room tax. Although, respondent may claim that
the 3% contractor's tax is imposed upon a different incidence i.e. the gross
receipts of petitioner tourist agency which he asserts includes the hotel room
charges entrusted to it, the effect would be to impose a tax, and though
different, it nonetheless imposes a tax actually on room charges. One way or
the other, it would not have the effect of promoting tourism in the Philippines
as that would increase the costs or expenses by the addition of a hotel room
tax in the overall expenses of said tourists. (Rollo, pp. 51-52)
WHEREFORE, the instant petition is DENIED. The decision of the Court of
Tax Appeals is AFFIRMED. No pronouncement as to costs.
SO ORDERED.
G.R. No. 78953 July 31, 1991
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
MELCHOR J. JAVIER, JR. and THE COURT OF TAX
APPEALS, respondents.
Elison G. Natividad for accused-appellant.
SARMIENTO, J.:p
Central in this controversy is the issue as to whether or not a taxpayer who
merely states as a footnote in his income tax return that a sum of money that
he erroneously received and already spent is the subject of a pending litigation
and there did not declare it as income is liable to pay the 50% penalty for filing
a fraudulent return.
This question is the subject of the petition for review before the Court of the
portion of the Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA)
in C.T.A. Case No. 3393, entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta,
in his capacity as Commissioner of Internal Revenue," which orders the
deletion of the 50% surcharge from Javier's deficiency income tax assessment
on his income for 1977.
The respondent CTA in a Resolution 2 dated May 25, 1987, denied the
Commissioner's Motion for Reconsideration 3 and Motion for New Trial 4 on the
deletion of the 50% surcharge assessment or imposition.
The pertinent facts as are accurately stated in the petition of private
respondent Javier in the CTA and incorporated in the assailed decision now
under review, read as follows:
xxx xxx xxx
2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner
(private respondent herein), received from the Prudential Bank and Trust
Company in Pasay City the amount of US$999,973.70 remitted by her sister,
Mrs. Dolores Ventosa, through some banks in the United States, among which
is Mellon Bank, N.A.
3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with
the Court of First Instance of Rizal (now Regional Trial Court), (docketed as
Civil Case No. 26899), against the petitioner (private respondent herein), his
wife and other defendants, claiming that its remittance of US$1,000,000.00
was a clerical error and should have been US$1,000.00 only, and praying that
the excess amount of US$999,000.00 be returned on the ground that the
defendants are trustees of an implied trust for the benefit of Mellon Bank with
the clear, immediate, and continuing duty to return the said amount from the
moment it was received.
4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an
Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-
P.C.) charging the petitioner (private respondent herein) and his wife with the
crime of estafa, alleging that they misappropriated, misapplied, and converted
to their own personal use and benefit the amount of US$999,000.00 which
they received under an implied trust for the benefit of Mellon Bank and as a
result of the mistake in the remittance by the latter.
5. That on March 15, 1978, the petitioner (private respondent herein) filed his
Income Tax Return for the taxable year 1977 showing a gross income of
P53,053.38 and a net income of P48,053.88 and stating in the footnote of the
return that "Taxpayer was recipient of some money received from abroad
which he presumed to be a gift but turned out to be an error and is now
subject of litigation."
6. That on or before December 15, 1980, the petitioner (private respondent
herein) received a letter from the acting Commissioner of Internal Revenue
dated November 14, 1980, together with income assessment notices for the
years 1976 and 1977, demanding that petitioner (private respondent herein)
pay on or before December 15, 1980 the amount of P1,615.96 and
P9,287,297.51 as deficiency assessments for the years 1976 and 1977
respectively. . . .
7. That on December 15, 1980, the petitioner (private respondent herein)
wrote the Bureau of Internal Revenue that he was paying the deficiency
income assessment for the year 1976 but denying that he had any undeclared
income for the year 1977 and requested that the assessment for 1977 be
made to await final court decision on the case filed against him for filing an
allegedly fraudulent return. . . .
8. That on November 11, 1981, the petitioner (private respondent herein)
received from Acting Commissioner of Internal Revenue Romulo Villa a letter
dated October 8, 1981 stating in reply to his December 15, 1980 letter-protest
that "the amount of Mellon Bank's erroneous remittance which you were able
to dispose, is definitely taxable." . . . 5
The Commissioner also imposed a 50% fraud penalty against Javier.
Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax
Appeals on December 10, 1981.
The respondent CTA, after the proper proceedings, rendered the challenged
decision. We quote the concluding portion:
We note that in the deficiency income tax assessment under consideration,
respondent (petitioner here) further requested petitioner (private respondent
here) to pay 50% surcharge as provided for in Section 72 of the Tax Code, in
addition to the deficiency income tax of P4,888,615.00 and interest due
thereon. Since petitioner (private respondent) filed his income tax return for
taxable year 1977, the 50% surcharge was imposed, in all probability, by
respondent (petitioner) because he considered the return filed false or
fraudulent. This additional requirement, to our mind, is much less called for
because petitioner (private respondent), as stated earlier, reflected in as 1977
return as footnote that "Taxpayer was recipient of some money received from
abroad which he presumed to be gift but turned out to be an error and is now
subject of litigation."
From this, it can hardly be said that there was actual and intentional fraud,
consisting of deception willfully and deliberately done or resorted to by
petitioner (private respondent) in order to induce the Government to give up
some legal right, or the latter, due to a false return, was placed at a
disadvantage so as to prevent its lawful agents from proper assessment of tax
liabilities. (Aznar vs. Court of Tax Appeals, L-20569, August 23, 1974, 56 (sic)
SCRA 519), because petitioner literally "laid his cards on the table" for
respondent to examine. Error or mistake of fact or law is not fraud. (Insular
Lumber vs. Collector, L-7100, April 28, 1956.). Besides, Section 29 is not too
plain and simple to understand. Since the question involved in this case is of
first impression in this jurisdiction, under the circumstances, the 50%
surcharge imposed in the deficiency assessment should be deleted. 7
The Commissioner of Internal Revenue, not satisfied with the respondent
CTA's ruling, elevated the matter to us, by the present petition, raising the
main issue as to:
WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50%
FRAUD PENALTY? 8
On the other hand, Javier candidly stated in his Memorandum, 9 that he "did
not appeal the decision which held him liable for the basic deficiency income
tax (excluding the 50% surcharge for fraud)." However, he submitted in the
same memorandum "that the issue may be raised in the case not for the
purpose of correcting or setting aside the decision which held him liable for
deficiency income tax, but only to show that there is no basis for the imposition
of the surcharge." This subsequent disavowal therefore renders moot and
academic the posturings articulated in as Comment 10 on the non-taxability of
the amount he erroneously received and the bulk of which he had already
disbursed. In any event, an appeal at that time (of the filing of the Comments)
would have been already too late to be seasonable. The petitioner, through
the office of the Solicitor General, stresses that:
xxx xxx xxx
The record however is not ambivalent, as the record clearly shows that private
respondent is self-convinced, and so acted, that he is the beneficial owner,
and of which reason is liable to tax. Put another way, the studied insinuation
that private respondent may not be the beneficial owner of the money or
income flowing to him as enhanced by the studied claim that the amount is
"subject of litigation" is belied by the record and clearly exposed as a
fraudulent ploy, as witness what transpired upon receipt of the amount.
Here, it will be noted that the excess in the amount erroneously remitted by
MELLON BANK for the amount of private respondent's wife was $999,000.00
after opening a dollar account with Prudential Bank in the amount of
$999,993.70, private respondent and his wife, with haste and dispatch, within
a span of eleven (11) electric days, specifically from June 3 to June 14, 1977,
effected a total massive withdrawal from the said dollar account in the sum of
$975,000.00 or P7,020,000.00. . . . 11
In reply, the private respondent argues:
xxx xxx xxx
The petitioner contends that the private respondent committed fraud by not
declaring the "mistaken remittance" in his income tax return and by merely
making a footnote thereon which read: "Taxpayer was the recipient of some
money from abroad which he presumed to be a gift but turned out to be an
error and is now subject of litigation." It is respectfully submitted that the said
return was not fraudulent. The footnote was practically an invitation to the
petitioner to make an investigation, and to make the proper assessment.
The rule in fraud cases is that the proof "must be clear and convincing"
(Griffiths v. Comm., 50 F [2d] 782), that is, it must be stronger than the "mere
preponderance of evidence" which would be sufficient to sustain a judgment
on the issue of correctness of the deficiency itself apart from the fraud penalty.
(Frank A. Neddas, 40 BTA 672). The following circumstances attendant to the
case at bar show that in filing the questioned return, the private respondent
was guided, not by that "willful and deliberate intent to prevent the
Government from making a proper assessment" which constitute fraud, but by
an honest doubt as to whether or not the "mistaken remittance" was subject to
tax.
First, this Honorable Court will take judicial notice of the fact that so-called
"million dollar case" was given very, very wide publicity by media; and only one
who is not in his right mind would have entertained the idea that the BIR would
not make an assessment if the amount in question was indeed subject to the
income tax.
Second, as the respondent Court ruled, "the question involved in this case is
of first impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition).
Even in the United States, the authorities are not unanimous in holding that
similar receipts are subject to the income tax. It should be noted that the
decision in the Rutkin case is a five-to-four decision; and in the very case
before this Honorable Court, one out of three Judges of the respondent Court
was of the opinion that the amount in question is not taxable. Thus, even
without the footnote, the failure to declare the "mistaken remittance" is not
fraudulent.
Third, when the private respondent filed his income tax return on March 15,
1978 he was being sued by the Mellon Bank for the return of the money, and
was being prosecuted by the Government for estafa committed allegedly by
his failure to return the money and by converting it to his personal benefit. The
basic tax amounted to P4,899,377.00 (See p. 6 of the Petition) and could not
have been paid without using part of the mistaken remittance. Thus, it was not
unreasonable for the private respondent to simply state in his income tax
return that the amount received was still under litigation. If he had paid the tax,
would that not constitute estafa for using the funds for his own personal
benefit? and would the Government refund it to him if the courts ordered him
to refund the money to the Mellon Bank? 12
xxx xxx xxx
Under the then Section 72 of the Tax Code (now Section 248 of the 1988
National Internal Revenue Code), a taxpayer who files a false return is liable
to pay the fraud penalty of 50% of the tax due from him or of the deficiency tax
in case payment has been made on the basis of the return filed before the
discovery of the falsity or fraud.
We are persuaded considerably by the private respondent's contention that
there is no fraud in the filing of the return and agree fully with the Court of Tax
Appeals' interpretation of Javier's notation on his income tax return filed on
March 15, 1978 thus: "Taxpayer was the recipient of some money from abroad
which he presumed to be a gift but turned out to be an error and is now
subject of litigation that it was an "error or mistake of fact or law" not
constituting fraud, that such notation was practically an invitation for
investigation and that Javier had literally "laid his cards on the table." 13
In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax
return was discussed in this manner:
. . . The fraud contemplated by law is actual and not constructive. It must be
intentional fraud, consisting of deception willfully and deliberately done or
resorted to in order to induce another to give up some legal right. Negligence,
whether slight or gross, is not equivalent to the fraud with intent to evade the
tax contemplated by law. It must amount to intentional wrong-doing with the
sole object of avoiding the tax. It necessarily follows that a mere mistake
cannot be considered as fraudulent intent, and if both petitioner and
respondent Commissioner of Internal Revenue committed mistakes in making
entries in the returns and in the assessment, respectively, under the inventory
method of determining tax liability, it would be unfair to treat the mistakes of
the petitioner as tainted with fraud and those of the respondent as made in
good faith.
Fraud is never imputed and the courts never sustain findings of fraud upon
circumstances which, at most, create only suspicion and the mere
understatement of a tax is not itself proof of fraud for the purpose of tax
evasion. 15
A "fraudulent return" is always an attempt to evade a tax, but a merely "false
return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16
In the case at bar, there was no actual and intentional fraud through willful and
deliberate misleading of the government agency concerned, the Bureau of
Internal Revenue, headed by the herein petitioner. The government was not
induced to give up some legal right and place itself at a disadvantage so as to
prevent its lawful agents from proper assessment of tax liabilities because
Javier did not conceal anything. Error or mistake of law is not fraud. The
petitioner's zealousness to collect taxes from the unearned windfall to Javier is
highly commendable. Unfortunately, the imposition of the fraud penalty in this
case is not justified by the extant facts. Javier may be guilty of swindling
charges, perhaps even for greed by spending most of the money he received,
but the records lack a clear showing of fraud committed because he did not
conceal the fact that he had received an amount of money although it was a
"subject of litigation." As ruled by respondent Court of Tax Appeals, the 50%
surcharge imposed as fraud penalty by the petitioner against the private
respondent in the deficiency assessment should be deleted.
WHEREFORE, the petition is DENIED and the decision appealed from the
Court of Tax Appeals is AFFIRMED. No costs.
SO ORDERED.
c. Income from whatever source
The late LINO GUTIERREZ substituted by ANDREA C. VDA. DE
GUTIERREZ, ANTONIO D. GUTIERREZ, GUILLERMO D. GUTIERREZ,
SANTIAGO D. GUTIERREZ and TOMAS D. GUTIERREZ,petitioners,
vs.
COLLECTOR (now COMMISSIONER) OF INTERNAL REVENUE,
respondent.
Rosendo J. Tansinsin, Sr., Rosendo Tansinsin, Jr. and Juan C. Nabong, Jr.for
petitioners.
Office of the Solicitor General for respondent.
BENGZON, J.P., J.:
Lino Gutierrez was primarily engaged in the business of leasing real property Alms to indigent family 15.00
for which he paid estate broker's privilege tax. He filed his income tax returns Capital expenditures:
for the years 1951, 1952, 1953 and 1954 on the following dates:
Electrical fixtures and supplies 100.00
Year Date Filed Transportation and other expenses to watch laborers in construction work
1951 March 1, 1952 516.00
1952 February 28, 1953 Realty tax not paid by former owner of property acquired by Gutierrez 350.00
1953 February 22, 1954 Litigation expenses to collect rental and eject lessee 702.65
1954 February 23, 1955 Other disallowed deductions:
and paid the corresponding tax declared therein.
Fines and penalties for late payment of taxes 64.48
On July 10, 1956 the Commissioner (formerly Collector) of Internal Revenue 1952
assessed against Gutierrez the following defiency income tax:
Personal expenses:
1951 . . . . . . . . . . . . . . P 1,400.00
1952 . . . . . . . . . . . . . . 672.00 Car expenses, salary of driver and car depreciation P1,454.37
1953 . . . . . . . . . . . . . . 5,161.00 Contribution to Lydia Samson and G. Trinidad 52.00
1954 . . . . . . . . . . . . . . 4,608.00 Officers' jewels and aprons donated to Biak-na-Bato Lodge No. 7, Free
Total . . . . . . . . . . . . . . Masons 280.00
P 11,841.00 Luncheon of Homeowners' Association 5.50
========== Ticket to opera "Aida" 15.00
The above defiency tax came about by the disallowance of deductions from 1953
gross income representing depreciation, expenses Gutierrez allegely incurred
in carrying on his business, and the addition to gross income of receipts which Personal expenses:
he did not report in his income tax returns. The disallowed business expenses
which were considered by the Commissioner either as personal or capital Car expenses, salary of driver, car depreciation P 1,409.24
expenditures consisted of: Cruise to Corregidor with Homeowners' Association 43.00
Contribution to alms to various individuals 70.00
1951 Tickets to operas 28.00
Capital expenditures:
Personal expenses:
Cost of one set of Comments on the Rules of Court by Moran P 145.00
Transportation expenses to attend funeral of various persons P 96.50 1954
Repair of car and salary of driver 59.80
Expenses in attending National Convention of Filipino Businessmen in Baguio Personal expenses:
121.35
Car expenses, salary of driver and car depreciation P 1,413.67
Furniture given as commission in connection with business transaction
115.00
Cost of iron door of Gutierrez' residence 55.00
Capital expenditures:
Painting of rental apartments P 908.00
Carpentry and lumber for rental apartments 335.83
Tinsmith and plumbing for rental apartments 605.25
Cement, tiles, gravel, sand and masonry for rental apartments 199.48
Iron bars, venetian blind, water pumps for rental apartments 1,340.00
Relocation and registration of property used in taxpayer's business
1,758.12
He also claimed the depreciation of his residence as follows:
including the said property was bought in Japanese military notes, converting
the buying price to its equivalent in PhilippineCommonwealth peso by the use
of the Ballantyne Scale of Values. At P1.30 Japanese military notes per
Commonwealth peso, the acquisition cost of P35,000.00 Japanese military
notes was valued at P26,923.00 PhilippineCommonwealth peso. Accordingly,
the Commissioner determined a profit of P3,476.92 after restoring to Gutierrez'
gross income the P5,231.80 deductionfor loss.
In another transaction, Gutierrez sold a piece of land for P1,200.00. Alleging
the said property was purchased for P1,200.00, he reported no profit
hereunder. However, after verifying the deed of acquisition, the Commissioner
discovered the purchase price to be only P800.00. Consequently, he
determined a profit of P400.00 which was added to the gross income for
1953.1wph1.t

1952 . . . . . . P 992.22 The understatement of profit from the sale of real estate may be explained
1953 . . . . . . 942.61 thus: In 1953 and 1954 Gutierrez sold four other properties upon which he
1954 . . . . . . 895.45 made substantial profits.2Convinced that said properties were capital assets,
The following are the items of income which Gutierrez did not declare in his he declared only 50% of the profits from their sale. However, treating said
income tax returns: properties as ordinary assets (as property held and used byGutierrez in his
business), the Commissioner taxed 100% of the profits from their disposition
1951 pursuant to Section 35 of the Tax Code.

Income of wife (admitted by Gutierrez) P 2,749.90.
1953
Overstatement of purchase price of real estate P 8,476.92
Understatement of profits from sale of real estate 5,803.74
1954
Understatement of profits from sale of real estate P 5,444.24
The overstatement of purchase price of real estate refers to the sale of two
pieces of property in 1953. In 1943 Gutierrez bought a parcel of land situated
along Padre Faura St. in Manila for P35,000.00. Sometime in 1953, he sold
the same for P30,400.00. Expenses of sale amounted to P631.80. In his
return he claimed a loss of P5,231.80. 1 However, the Commissioner,
Having unsuccessfully questioned the legality and correctness of the aforesaid
assessment, Gutierrez instituted on February 17, 1958, the Commissioner
issued a warrant of distraint and levy on one of Gutierrez' real properties but
desisted from enforcing the same when Gutierrez filed a bond to assure
payment of his tax liability.
In a decision dated January 28, 1962, the Court of Tax Appeals upheld in toto
the assessment of the Commissioner of Internal Revenue. Hence, this appeal.
On October 18, 1962, Lino Guttierrez died and he was substituted by Andrea
C. Vda. de Gutierrez, Antonio D. Gutierrez, Santiago D. Gutierrez, Guillermo
D. Gutierrez and Tomas D. Gutierrez, his heirs,as party petitioners.
The issues are: (1) Are the taxpayer's aforementioned claims for deduction
proper and allowable? (2) May the Ballantyne Scale of Values be applied
indetermining the acquisition cost in 1943 of a real property sold in 1953, for
income tax purposes? (3) Are real properties used in the trade or business of
the taxpayer capital or ordinary assets? (4) Has the right of the Commissioner
of Internal Revenue to collect the deficiency income tax for the years 1951 and
1952 prescribed? (5) Has the right of the Commissioner of Internal Revenue to
collect by distraint and levy the deficiency income tax for 1953 prescribed? If
not, may the taxpayer's rea lproperty be distrained and levied upon without
first exhausting his personal property?
We come first to question whether or not the deductions claimed by Gutierrez
are allowable. Section 30(a) of the Tax Code allows business expenses tobe
deducted from gross income. We quote:
SEC. 30. Deductions from gross income. In computing net income there
shall be allowed as deductions
Expenses:
In general. All the ordinary and necessary expenses paid or incurred
during the taxable year in carrying on any trade or business, including
a reasonable allowance for salaries or other compensation for personal
services actually rendered; travelling expenses while away from home
in the pursuit of a trade or business; and rentals or other payments
required to be made as a condition to be continued use of possession,
for the purposes of the trade or business, or property to which the
taxpayer has not taken or is not taking title or in which he has no
equity.
To be deductible, therefore, an expense must be (1) ordinary and necessary;
(2) paid or incurred within the taxable year; and, (3) paid or incurred in
carrying on a trade or business. 3
The transportation expenses which petitioner incurred to attend the funeral of
his friends and the cost of admission tickets to operas were expenses relative
to his personal and social activities rather than to his business of leasing real
estate. Likewise, the procurement and installation of an iron door to is
residence is purely a personal expense. Personal, living, or family expenses
are not deductible. 4
On the other hand, the cost of furniture given by the taxpayer as commission
in furtherance of a business transaction, the expenses incurred in attending
the National Convention of Filipino Businessmen, luncheon meeting and
cruise to Corregidor of the Homeowners' Association were shown to have
been made in the pursuit of his business. Commissions given in consideration
for bringing about a profitable transaction are part of the cost of the business
transaction and are deductible.
The record shows that Gutierrez was an officer of the Junior Chamber of
Commerce which sponsored the National Convention of Filipino Businessmen.
He was also the president of the Homeowners' Association, an organization
established by those engaged in the real estate trade. Having proved that his
membership thereof and activities in connection therewith were solely to
enhance his business, the expenses incurred thereunder are deductible as
ordinary and necessary business expenses.
With respect to the taxpayer's claim for deduction for car expenses, salary of
his driver and car depreciation, one-third of the same was disallowed by the
Commissioner on the ground that the taxpayer used his car and driver both for
personal and business purposes. There is no clear showing, however, that the
car was devoted more for the taxpayer's business than for his personal and
business needs. 5 According to the evidence, the taxpayer's car was utilized
both for personal and business needs. We therefore find it reasonable to allow
as deduction one-half of the driver's salary, car expenses and depreciation.
The electrical supplies, paint, lumber, plumbing, cement, tiles, gravel, masonry
and labor used to repair the taxpayer's rental apartments did not increase the
value of such apartments, or prolong their life. They merely kept the
apartments in an ordinary operating condition. Hence, the expenses incurred
therefor are deductible as necessary expenditures for the maintenance of the
taxpayer's business.

Similarly, the litigation expenses defrayed by Gutierrez to collect apartment
rentals and to eject delinquent tenants are ordinary and necessary expenses
in pursuing his business. It is routinary and necessary for one in the leasing
business to collect rentals and to eject tenants who refuse to pay their
accounts.
The following are not deductible business expenses but should be integrated
into the cost of the capital assets for which they were incurred and depreciated
yearly: (1) Expenses in watching over laborers in construction work. Watching
over laborers is an activity more akin to the construction work than to running
the taxpayer's business. Hence, the expenses incurred therefor should form
part of the construction cost. (2) Real estate tax which remained unpaid by the
former owner of Gutierrez' rental property but which the latter paid, is an
additional cost to acquire such property and ought therefore to be treated as
part of the property's purchase price. (3) The iron bars, venetian blind and
water pump augmented the value of the, apartments where they were
installed. Their cost is not a maintenance charge, 6 hence, not deductible.. 7
(4) Expenses for the relocation, survey and registration of property tend to
strengthen title over the property, hence, they should be considered as
addition to the costs of such property. (5) The set of "Comments on the Rules
of Court" having a life span of more than one year should be depreciated
ratably during its whole life span instead of its total cost being deducted in one
year.
Coming to the claim for depreciation of Gutierrez' residence, we find the same
not deductible. A taxpayer may deduct from gross income a reasonable
allowance for deterioration of property arising out of its use or employment in
business or trade. 8 Gutierrez' residence was not used in his trade or
business.
Gutierrez also claimed for deduction the fines and penalties which he paid for
late payment of taxes. While Section 30 allows taxes to be deducted from
gross income, it does not specifically allow fines and penalties to be so
deducted. Deductions from gross income are matters of legislative grace; what
is not expressly granted by Congress is withheld. Moreover, when acts are
condemned, by law and their commission is made punishable by fines or
forfeitures, to allow them to be deducted from the wrongdoer's gross income,
reduces, and so in part defeats, the prescribed punishment..9
As regards the alms to an indigent family and various individuals, contributions
to Lydia Yamson and G. Trinidad and a donation consisting of officers' jewels
and aprons to Biak-na-Bato Lodge No. 7, the same are not deductible from
gross income inasmuch as their recipients have not been shown to be among
those specified by law. Contributions are deductible when given to the
Government of the Philippines, or any of its political subdivisions for
exclusively public purposes, to domestic corporations or associations
organized and operated exclusively for religious, charitable, scientific, athletic,
cultural or educational purposes, or for the rehabilitation of veterans, or to
societies for the prevention of cruelty to children or animals, no part of the net
income of which inures to the benefit of any private stockholder or individual.
10
We come to the question of whether or not the Ballantyne Scale of Values can
be applied to tax cases.
Sometime in 1943 Gutierrez bought a piece of real estate in Manila for a price
of P35,000.00. In 1953 he sold said property for P30,400.00, thereby incurring
a loss which he claimed as deduction in his income tax return for 1953. The
Commissioner of Internal Revenue, convinced that the purchase price of the
property in 1943 was in Japanese military notes, converted said purchase
price into Philippine Commonwealth pesos by the use of the Ballantyne Scale
of Values. As a result, the Commissioner found Gutierrez to have profited,
instead of lost in the sale.
Firstly, Gutierrez maintains that the purchase price was paid for in
Commonwealth pesos. On the other hand the Commissioner insists that
inasmuch as the prevailing currency in the City of Manila in 1943 was the
Japanese military issue, the transaction could have been in said military notes.
The evidence offered by Gutierrez, consisting of the testimony of his son to
the effect that it was he who carried the bundle of Commonwealth pesos and
Japanese military notes when his father purchased the property, did not
convince the Tax Court. No cogent reason to alter the court a quo's finding of
fact in this regard has been given. There is no definite showing that Gutierrez
paid for the property in Commonwealth pesos. Considering that in 1943 the
medium of exchange in Manila was the Japanese military notes, the use of
which the Japanese Military Government enforced with stringent measures,
we are inclined to concur with the finding that the purchase price was in
Japanese military notes. We are specifically mindful of the fact that Gutierrez
sold the property in 1953 for only P30,400.00 at a time when the price of real
estate in the City of Manila was much greater than in 1943.
It is further contended by Gutierrez that the money he used to pay for the
purchase of the property in question came from the proceeds of merchandise
acquired prior to World War II but which he sold after Manila was occupied by
the Japanese military forces, hence, the purchase price should be deemed to
have been made in Commonwealth pesos inasmuch as the aforesaid
merchandise was purchased in Commonwealth pesos. This contention, if true,
strengthens our conclusion that the real estate in question was bought in
Japanese military notes. For, at the time Gutierrez sold his merchandise, the
prevailing currency in the City of Manila was the Japanese military money.
Consequently, the proceeds therefrom, which were used to buy the real estate
in question, were Japanese military notes.
Gutierrez assails the use of the Ballantyne Scale of Values in converting the
purchase price of the real estate in question from Japanese military notes to
Philippine Commonwealth pesos on the ground that (1) the Ballantyne Scale
of Values was intended only for transactions entered into by parties voluntarily
during the Japanese occupation, wherein a portion of the contract was left
unperformed until liberation of the Philippines by the Americans; (2) that such
Scale of Values cannot be the basis of a tax, for it is not a law.
In determining the gain or loss from the sale of property the purchase price
and the selling price ought to be in the same currency. Since in this case the
purchase price was in Japanese military notes and the selling price was in our
present legal tender, the Japanese military notes should be converted to the
present currency. Since the only standard scale recognized by courts for the
purpose is the Ballantyne Scale of Values, we find it compelling to use such
table of values rather than adopt an arbitrary scale. It may not be amiss to
state in this connection that the Ballantyne Scale of Values is not being used
herein as the authority to impose the tax, but only as a medium of computing
the tax base upon which the tax is to be imposed.
It is furthermore proffered by the taxpayer that in determining gain or loss, the
real value of the Commonwealth peso at the time the property was purchased
and the value of the Republic peso at the time. the same property was sold
should be considered. The Commonwealth peso and the Republic peso are
the same currency, with the same intrinsic value, sanctioned by the same
authorities. Both are legal tender and accepted at face value regardless of
fluctuation in their buying power. The 1941 Commonwealth peso when used to
buy in 1963 or in 1965 is accorded the same value: one peso.
In his income tax returns for 1953 and 1954, Gutierrez reported only 50% of
profits he realized from the sale of real properties during the years 1953 and
1954 on the ground that said properties were capital assets. Profits from the
sale of capital assets are taxable to the extent of 50% thereof pursuant to
Section 34 of the Tax Code.
Section 34 provides:
SEC. 34. Capital gains and losses. (a) Definitions. As used in this title
Capital assets. The term "capital assets" means property held by the
taxpayer (whether or not connected with his trade or business), but does not
include stock in trade of the taxpayer or other property of a kind which would
properly be included in the inventory of the taxpayer if on hand at the close of
the taxable year, or property held by the taxpayer primarily for sale to
customers in the ordinary course of his trade or business, or property used in
the trade or business, of a character which is subject to the allowance for
depreciation provided in subsection (f) of section thirty; or real property used in
the trade or business of the taxpayer.
xxx xxx xxx
Percentage taken into account. In the case of a taxpayer, other than a
corporation, only the following percentages of the gain or loss recognized
upon the sale or exchange of capital asset hall be taken into account in
computing net capital gain, net capital loss, and net income:
One hundred per centum if the capital asset has been held for not
more than twelve months;
Fifty per centum if the capital asset has been held for not more than
twelve months.
Section 34, before it was amended by Republic Act 82 in 1947, considered as
capital assets real property used in the trade or business of a taxpayer.
However, with the passage of Republic Act 82, Congress classified "real
property used in the trade or business of the taxpayer" is ordinary asset. The
explanatory note to Republic Act 82 says "... the words "or real property
used in the trade or business of the taxpayer" have been included among the
non-capital assets. This has the effect of withdrawing the gain or loss from the
sale or exchange of real property used in the trade or business of the taxpayer
from the operation of the capital gains and losses provisions. As such real
property is used in the trade or business of the taxpayer, it is logical that the
gain or loss from the sale or exchange thereof should be treated as ordinary
income or loss. 11 Accordingly, the real estate, admittedly used by Gutierrez in
his business, which he sold in 1953 and 1954 should be treated as ordinary
assets and the gain from the sale thereof, as ordinary gain, hence, fully
taxable. 12
With regard to the issue of the prescription of the Commissioner's right to
collect deficiency tax for 1951 and 1952, Gutierrez claims that the counting of
the 5-year period to collect income tax should start from the time the income
tax returns were filed. He, therefore, urges us to declare the Commissioner's
right to collect the deficiency tax for 1951 and 1952 to have prescribed, the
income tax returns for 1951 and 1952 having been filed in March 1952 and on
February 28, 1953, respectively, and the action to collect the tax having been
instituted on March 5, 1958 when the Commissioner filed his answer to the
petition for review in C.T.A. Case No. 504. On the other hand, the
Commissioner argues that the running of the prescriptive period to collect
commences from the time of assessment. Inasmuch as the tax for 1951 and
1952 were assessed only on July 10, 1956, less than five years lapsed when
he filed his answer on March 5, 1958.
The period of limitation to collect income tax is counted from the assessment
of the tax as provided for in paragraph (c) of Section 332 quoted below:
SEC. 332(c). Where the assessment of any internal revenue tax has been
made within the period of limitation above prescribed such tax may be
collected by distraint or levy or by a proceeding in court, but only if begun (1)
within five years after the assessment of the tax, or (2) prior to the expiration
of any period for collection agreed upon in writing by the Collector of Internal
Revenue and the taxpayer before the expiration of such five-year period. The
period so agreed upon may be extended by subsequent agreements in writing
made before the expiration of the period previously agreed upon.
Inasmuch as the assessment for deficiency income tax was made on July 10,
1956 which is 7 months and 25 days prior to the action for collection, the right
of the Commissioner to collect such tax has not prescribed.
The next issue relates to the prescription of the right of the Commissioner of
Internal Revenue to collect the deficiency tax for 1954 by distraint and levy.
The pertinent provision of the Tax Code states:
SEC. 51(d). Refusal or neglect to make returns; fraudulent returns, etc. In
cases of refusal or neglect to make a return and in cases of erroneous, false,
or fraudulent returns, the Collector of Internal Revenue shall, upon the
discovery thereof, at any time within three years after said return is due or has
been made, make a return upon information obtained as provided for in this
code or by existing law, or require the necessary corrections to be made, and
the assessment made by the Collector of Internal Revenue thereon shall be
paid by such person or corporation immediately upon notification of the
amount of such assessment.
On February 23, 1955 Gutierrez filed his income tax return for 1954 and on Add: Disallowed deductions for salary of
February 24, 1958 the Commissioner of Internal Revenue issued a warrant of driver and car expenses 29.90
distraint and levy to collect the tax due thereunder. Gutierrez contends that the P29,501.81
Commissioner's right to issue said warrant is barred, for the same was issued Less: Allowable deductions:
more than 3 years from the time he filed his income tax return. On the other Expenses in attending National
hand, the Commissioner of Internal Revenue maintains that his right did not Convention of Filipino Businessmen P 121.35
lapse inasmuch as from the last day prescribed by law for the filing of the 1954 Repair of rental apartments 802.65 924.00
return to the date when he issued the warrant of distraint and levy, less than 3 Net income
years passed. The question now is: should the counting of the prescriptive P30,425.71
period commence from the actual filing of the return or from the last day Less: Personal exemption 3,600.00
prescribed by law for the filing thereof? Amount subject to tax
P26,825.71
We observe that Section 51(d) speaks of erroneous, false or fraudulent Tax due thereon P 5,668.00
returns, and refusal or neglect of the taxpayer to file a return. It also provides Less tax already paid 3,981.00
for two dates from which to count the three-year prescriptive period, namely, Deficiency income tax due
the date when the return is due and the date the return has been made. We P 1,687.00
are inclined to conclude that the date when the return is due refers to cases ==========
where the taxpayer refused or neglected to file a return, and the date when the 1952
return has been made refers to instances where the taxpayer filed erroneous, Net income per investigation P21,632.22
false or fraudulent returns. Since Gutierrez filed an income tax return, the Add: Disallowed deductions:
three-year prescriptive period should be counted from the time he filed such Salary of driver P 260.67
return. From February 23, 1955 when the income tax return for 1954 was filed, Car expenses 401.51
to February 24, 1958, when the warrant of distraint and levy was issued, 3 Car depreciation 65.00 727.18
years and 2 days elapsed. The right of the Commissioner to issue said P22,359.40
warrant of distraint and levy having lapsed by two days, the warrant issued is Less Allowable deduction:
null and void. Luncheon, Homeowners' Association 5.50
Net income
The above finding has made academic the question of whether or not the P22,364.90
warrant of distraint and levy can be enforced against the taxpayer's real Less: Personal exemption 3,600.00
property without first exhausting his personal properties. Amount subject to tax
P18,764.90
In resume the tax liability of Lino Gutierrez for 1951, 1952, 1953 and 1954 Tax due thereon P 3,324.00
may be computed as follows: Less tax already paid 2,476.00
Deficiency income tax due
1951 848.00
Net income per investigation P29,471.81 ==========
1953
Net income per investigation
Add: Disallowed deductions:
Salary of driver P 140.00
Car expenses 406.00
Car depreciation 58.50 604.50
P69,785.40
Less: Allowable deduction:
Cruise to Corregidor with Homeowners'
Association 42.00
Net Income
P69,828 40
Less: Personal exemption
Amount subject to tax
P66,228.40
Tax due thereon P15,179.00
Less tax already paid 9,805.00
Deficiency income tax due
P 5,374.00
==========
1954
Net income per investigation
Add: Disallowed deductions:
Salary of driver P 140.00
Car expenses 414.18
Car depreciation 72.65 626.83
P44,508.75
Less: Allowable deductions:
Furniture given in connection with business transaction P 115.00
Repairs of rental apartments
Net income
P42,345.19
Less: Personal exemption
Amount subject to tax
P39,345.19
Tax due thereon P 9,984.00
Less tax already paid 5,964.00
P69,180.91 Deficiency income tax due
P 4,020.00
==========
S U M MAR Y
1951 . . . . . . . . . . . . . . . . P 1,687.00
1952 . . . . . . . . . . . . . . . . 848.00
1953 . . . . . . . . . . . . . . . . 5,374.00
1954 . . . . . . . . . . . . . . . . 4,020.00
TOTAL . . . . . . . . . .
P 11,929.00
=========
3,600.00 WHEREFORE, the decision appealed from is modified and Lino Gutierrez
and/or his heirs, namely, Andrea C. Vda. de Gutierrez, Antonio D. Gutierrez,
Santiago D. Gutierrez, Guillermo D. Gutierrez and Tomas D. Gutierrez, are
ordered to pay the sums of P1,687.00, P848.00, P5,374.00, and P4,020.00,
as deficiency income tax for the years 1951, 1952, 1953 and 1954,
respectively, or a total of P11,929.00, plus the statutory penalties in case of
delinquency. No costs. So ordered.
Bengzon, C.J., Bautista Angelo, Concepcion, Reyes, J.B.L., Barrera, Paredes,
P43,881.92 Dizon, Makalintal and Zaldivar, JJ., concur.
Regala, J., took no part.
James vs US
Facts[edit]
The defendant, Eugene James, was an official in a labor union who had
embezzled more than $738,000 in union funds, and did not report these
amounts on his tax return. He was tried for tax evasion, and claimed in his
2,048.56 2,163.56 defense that embezzled funds did not constitute taxable income. His argument
was that just as the receipt of loan proceeds is not taxable to the borrower
(because of the borrower's corresponding obligation to repay the loan), the
3,000.00 person who embezzles money should not be treated as having received
income, since that person is legally obligated to return those funds to their
rightful owner. Indeed, Eugene James pointed out, the Supreme Court had
previously made such a determination in Commissioner v. Wilcox, 327 U.S.
 404 (1946). However, this defense was unavailing in the trial court, where
Eugene James was convicted and sentenced to three years in prison.
Issue[edit]
The Supreme Court was called upon to determine whether the receipt of
embezzled funds constitutes income taxable to the wrongdoer, even though
an obligation to repay exists.
Holding[edit]
The Supreme Court ruled that under section 22(a) of the Internal Revenue
Code of 1939 and section 61(a) of the Internal Revenue Code of 1954, the
receipt of embezzled funds was includable in the gross income of the
wrongdoer and was taxable to the wrongdoer, even though the wrongdoer had
an obligation to return the funds to the rightful owner.
CIR vs GLENSHAW GLASS
This litigation involves two cases with independent factual backgrounds, yet
presenting the identical issue. The two cases were consolidated for argument
before the Court of Appeals for the Third Circuit, and were heard en banc. The
common question is whether money received as exemplary damages for fraud or
as the punitive two-thirds portion of a treble damage antitrust recovery must be
reported by a taxpayer as gross income under 22(a) of the Internal Revenue
Code of 1939. [Footnote 1] In a single opinion, 211 F.2d 928, the Court of Appeals
affirmed the Tax Court's separate rulings in favor of the taxpayers. 18 T.C. 860; 19
T.C. 637. Because of the frequent recurrence of the question and differing
interpretations by the lower courts of this Court's decisions bearing upon the
problem, we granted the Commissioner of Internal Revenue's ensuing petition for
certiorari. 348 U.S. 813.
The facts of the cases were largely stipulated, and are not in dispute. So far as
pertinent, they are as follows:
Commissioner v. Glenshaw Glass Co. -- The Glenshaw Glass Company, a
Pennsylvania corporation, manufactures glass bottles and containers. It was
engaged in protracted litigation with the Hartford-Empire Company, which
manufactures machinery of a character used by Glenshaw. Among the claims
advanced by Glenshaw
Page 348 U. S. 428
were demands for exemplary damages for fraud [Footnote 2] and treble damages
for injury to its business by reason of Hartford's violation of the federal antitrust
laws. [Footnote 3] In December, 1947, the parties concluded a settlement of all
pending litigation by which Hartford paid Glenshaw approximately $800,000.
Through a method of allocation which was approved by the Tax Court, 18 T.C.
860, 870-872, and which is no longer in issue, it was ultimately determined that, of
the total settlement, $324,529.94 represented payment of punitive damages for
fraud and antitrust violations. Glenshaw did not report this portion of the
settlement as income for the tax year involved. The Commissioner determined a
deficiency, claiming as taxable the entire sum less only deductible legal fees. As
previously noted, the Tax Court and the Court of Appeals upheld the taxpayer.
Commissioner v. William Goldman Theatres, Inc. -- William Goldman Theatres,
Inc., a Delaware corporation operating motion picture houses in Pennsylvania,
sued Loew's, Inc., alleging a violation of the federal antitrust laws and seeking
treble damages. After a holding that a violation had occurred, William Goldman
Theatres, Inc. v. Loew's Inc., 150 F.2d 738, the case was remanded to the trial
court for a determination of damages. It was found that Goldman had suffered a
loss of profits equal to $125,000, and was entitled to treble damages in the sum of
$375,000. William Goldman Theatres, Inc. v. Loew's, Inc., 69 F.Supp.
103, aff'd 164 F.2d 1021, cert. denied, 334 U.S. 811. Goldman reported only
$125,000 of the recovery as gross income, and claimed that the $250,000
Page 348 U. S. 429
balance constituted punitive damages, and, as such, was not taxable. The Tax
Court agreed, 19 T.C. 637, and the Court of Appeals, hearing this with
the Glenshaw case, affirmed. 211 F.2d 928.
It is conceded by the respondents that there is no constitutional barrier to the
imposition of a tax on punitive damages. Our question is one of statutory
construction: are these payments comprehended by 22(a)?
The sweeping scope of the controverted statute is readily apparent:
"SEC. 22. GROSS INCOME."
"(a) GENERAL DEFINITION. '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 professions, vocations, trades,
businesses, commerce, or sales, or dealings in property, whether real or personal,
growing out of the ownership or use of or interest in such property; also from
interest, rent, dividends, securities, or the transaction of any business carried on
for gain or profit, or gains or profits and income derived from any source
whatever. . . ."
(Emphasis added.) [Footnote 4]
This Court has frequently stated that this language was used by Congress to exert
in this field "the full measure of its taxing power." Helvering v. Clifford, 309 U. S.
331, 309 U. S. 334; Helvering v. Midland Mutual Life Ins. Co., 300 U. S. 216, 300
U. S. 223; Douglas v. Willcuts, 296 U. S. 1, 296 U. S. 9; Irwin v. Gavit, 268 U. S.
161, 268 U. S. 166. Respondents contend that punitive damages, characterized
as "windfalls" flowing from the culpable conduct of third parties, are not within the
scope of the section. But Congress applied no limitations as to the source of
taxable receipts, nor restrictive
Page 348 U. S. 430
labels as to their nature. And the Court has given a liberal construction to this
broad phraseology in recognition of the intention of Congress to tax all gains
except those specifically exempted. Commissioner v. Jacobson, 336 U. S. 28, 336
U. S. 49; Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 87-91.
Thus, the fortuitous gain accruing to a lessor by reason of the forfeiture of a
lessee's improvements on the rented property was taxed in Helvering v.
Bruun, 309 U. S. 461.Cf. Robertson v. United States, 343 U. S. 711; Rutkin v.
United States, 343 U. S. 130; United States v. Kirby Lumber Co., 284 U. S. 1.
Such decisions demonstrate that we cannot but ascribe content to the catchall
provision of 22(a), "gains or profits and income derived from any source
whatever." The importance of that phrase has been to frequently recognized since
its first appearance in the Revenue Act of 1913 [Footnote 5] to say now that it
adds nothing to the meaning of "gross income."
Nor can we accept respondents' contention that a narrower reading of 22(a) is
required by the Court's characterization of income in Eisner v. Macomber, 252 U.
S. 189, 252 U. S. 207, as "the gain derived from capital, from labor, or from both
combined." [Footnote 6] The Court was there endeavoring to determine whether
the distribution of a corporate stock dividend constituted a realized gain to the
shareholder, or changed "only the form, not the essence," of
Page 348 U. S. 431
his capital investment. Id. at 252 U. S. 210. It was held that the taxpayer had
"received nothing out of the company's assets for his separate use and
benefit." Id. at 252 U. S. 211. The distribution, therefore, was held not a taxable
event. In that context -- distinguishing gain from capital -- the definition served a
useful purpose. But it was not meant to provide a touchstone to all future gross
income questions. Helvering v. Bruun, supra, at 309 U. S. 468-469; United States
v. Kirby Lumber Co., supra, at 284 U. S. 3.
Here, we have instances of undeniable accessions to wealth, clearly realized, and
over which the taxpayers have complete dominion. The mere fact that the
payments were extracted from the wrongdoers as punishment for unlawful
conduct cannot detract from their character as taxable income to the recipients.
Respondents concede, as they must, that the recoveries are taxable to the extent
that they compensate for damages actually incurred. It would be an anomaly that
could not be justified in the absence of clear congressional intent to say that a
recovery for actual damages is taxable, but not the additional amount extracted as
punishment for the same conduct which caused the injury. And we find no such
evidence of intent to exempt these payments.
It is urged that reenactment of 22(a) without change since the Board of Tax exemption provision in the Code. We would do violence to the plain meaning of
Appeals held punitive damages nontaxable in Highland Farms Corp., 42 B.T.A. the statute and restrict a clear legislative attempt to
1314, indicates congressional satisfaction with that holding. Reenactment --
particularly without the slightest affirmative indication that Congress ever had Page 348 U. S. 433
the Highland Farms decision before it -- is an unreliable indicium, at
best. Helvering v. Wilshire Oil Co., 308 U. S. 90, 308 U. S. 100-101; Koshland v. bring the taxing power to bear upon all receipts constitutionally taxable were we to
Helvering, 298 U. S. 441, 298 U. S. 447. Moreover, the Commissioner promptly say that the payments in question here are not gross income. See Helvering v.
published his nonacquiescence in this portion of the Highland Farms holding, Midland Mutual Life Ins. Co., supra, at 300 U. S. 223.
[Footnote 7] and has,
Reversed.
Page 348 U. S. 432
MR. JUSTICE DOUGLAS dissents.
before and since, consistently maintained the position that these receipts are
taxable. [Footnote 8] It therefore cannot be said with certitude that Congress MR. JUSTICE HARLAN took no part in the consideration or decision of this case.
intended to carve an exception out of 22(a)'s pervasive coverage. Nor does the
1954 Code's [Footnote 9] legislative history, with its reiteration of the proposition * Together with Commissioner of Internal Revenue v. William Goldman Theaters,
that statutory gross income is "all-inclusive," [Footnote 10] give support to Inc., which was a separate case decided by the Court of Appeals in the same
respondents' position. The definition of gross income has been simplified, but no opinion.
effect upon its present broad scope was intended. [Footnote 11] Certainly punitive
damages cannot reasonably be classified as gifts, cf. Commissioner v.
Jacobson, 336 U. S. 28, 336 U. S. 47-52, nor do they come under any other