Madrigal vs Rafferty

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

FACTS:

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

ISSUE: Whether or not the income reported by Madrigal on 1915 should be

divided into 2 in computing for the additional income tax.

HELD:

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

Fisher v. Trinidad
G.R. No. L-17518 October 30, 1922

FACTS:

That during the year 1919 the Philippine American Drug Company was a corporation duly
organized and existing under the laws of the Philippine Islands, doing business in the City of
Manila; that he appellant was a stockholder in said corporation; that said corporation, as result
of the business for that year, declared a "stock dividend"; that the proportionate share of said
stock divided of the appellant was P24,800; that the stock dividend for that amount was issued
to the appellant; that thereafter, in the month of March, 1920, the appellant, upon demand of
the appellee, paid under protest, and voluntarily, unto the appellee the sum of P889.91 as
income tax on said stock dividend. For the recovery of that sum (P889.91) the present action
was instituted. The defendant demurred to the petition upon the ground that it did not state
facts sufficient to constitute cause of action. The demurrer was sustained and the plaintiff
appealed.

ISSUE:

Whether or not the income received as dividends is taxable as an income?

HELD:

No.

Generally speaking, stock dividends represent undistributed increase in the capital of

corporations or firms, joint stock companies, etc., etc., for a particular period. They are used to
show the increased interest or proportional shares in the capital of each stockholder. In other
words, the inventory of the property of the corporation, etc., for particular period shows an
increase in its capital, so that the stock theretofore issued does not show the real value of the
stockholder's interest, and additional stock is issued showing the increase in the actual capital,
or property, or assets of the corporation, etc.

Having reached the conclusion, supported by the great weight of the authority, that "stock
dividends" are not "income," the same cannot be taxes under that provision of Act No. 2833
which provides for a tax upon income. Under the guise of an income tax, property which is not
an income cannot be taxed. When the assets of a corporation have increased so as to justify
the issuance of a stock dividend, the increase of the assets should be taken account of the
Government in the ordinary tax duplicates for the purposes of assessment and collection of an
additional tax.

ALEXANDER HOWDEN & CO., LTD., H. G. CHESTER & OTHERS vs CIR

FACTS:

1. In 1950 the Commonwealth Insurance Co., a domestic corporation, entered into reinsurance contracts with
32 British insurance companies not engaged in trade or business in the Philippines, whereby the former
agreed to cede to them a portion of the premiums on insurances on fire, marine and other risks it has
underwritten in the Philippines.

2. The reinsurance contracts were prepared and signed by the foreign reinsurers in England and sent to Manila
where Commonwealth Insurance Co. signed them.

3. Alexander Howden & Co., Ltd., also a British corporation, represented the British insurance companies.

4. Pursuant to the contracts, Commonwealth Insurance Co remitted P798,297.47 to Alexander Howden & Co.,
Ltd., as reinsurance premiums.

5. In behalf of Alexander Howden & Co., Ltd., Commonwealth Insurance Co. filed an income tax return
declaring the sum of P798,297.47, with accrued interest in the amount of P4,985.77, as Alexander Howden
& Co., Ltd.'s gross income for calendar year 1951. It also paid the BIR P66,112.00 income tax.

6. On May 12, 1954, Alexander Howden & Co., Ltd. filed with the BIR a claim for refund of the P66,112.00,
later reduced to P65,115.00, because it agreed to the payment of P977.00 as income tax on the
P4,985.77 accrued interest.

7. A ruling of the CIR was invoked, stating that it exempted from withholding tax reinsurance premiums
received from domestic insurance companies by foreign insurance companies not authorized to do business
in the Philippines.

8. Subsequently, petitioner. instituted an action in the CFI of Manila for the recovery of the amount claimed.
Tax Court denied the claim.

ISSUE#1: Are portions of premiums earned from insurances locally underwritten by a domestic corporation, ceded to
and received by non-resident foreign reinsurance companies, thru a non-resident foreign insurance broker, pursuant
to reinsurance contracts signed by the reinsurers abroad but signed by the domestic corporation in the Philippines,
subject to income tax or not?

HELD: YES. Section 24 of the National Internal Revenue Code subjects to tax a non-resident foreign corporation's
income from sources within the Philippines.

RATIO:

 Appellants contends that the reinsurance premiums came from sources outside the Philippines, for these
reasons: (1) The contracts of reinsurance, out of which the reinsurance premiums were earned, were
prepared and signed abroad (2) The reinsurers, not being engaged in business in the Philippines, received
the reinsurance premiums as income from their business conducted in England and, as such, taxable in
 England; and, (3) Section 37 of the Tax Code, enumerating what are income from sources within the
Philippines, does not include reinsurance premiums.
 The source of an income is the property, activity or service that produced the income The reinsurance
premiums remitted to appellants by virtue of the reinsurance contracts, had for their source the undertaking
to indemnify Commonwealth Insurance Co. against liability. Said undertaking is the activity that
produced the reinsurance premiums, and the same took place in the Philippines.
o In the first place, the reinsured, the liabilities insured and the risks originally underwritten by
Commonwealth Insurance Co., upon which the reinsurance premiums and indemnity were
based, were all situated in the Philippines.
o Secondly, contrary to appellants' view, the reinsurance contracts were perfected in the
Philippines, for Commonwealth Insurance Co. signed them last in Manila.
o Thirdly, the parties to the reinsurance contracts in question evidently intended Philippine
law to govern. Article 11 thereof provided for arbitration in Manila, and the contracts provided for
the use of Philippine currency as the medium of exchange and for the payment of Philippine taxes.
 Section 24 of the Tax Code does not require a foreign corporation to be engaged in business in the
Philippines in order for its income from sources within the Philippines to be taxable. It subjects foreign
corporations not doing business in the Philippines to tax for income from sources within the Philippines. If by
source of income is meant the business of the taxpayer, foreign corporations not engaged in business in the
Philippines would be exempt from taxation on their income from sources within the Philippines.
 "Income" refers to the flow of wealth. Such flow, proceeded from the Philippines. Such income enjoyed the
protection of the Philippine Government. As wealth flowing from within the taxing jurisdiction of the
Philippines and in consideration for protection accorded it by the Philippines, said income should properly
share the burden of maintaining the government.

 Appellants further contend that reinsurance premiums not being among those mentioned in Section 37 of
the Tax Code as income from sources within the Philippines, the same should not be treated as such.
Section 37, however, is not an all-inclusive enumeration. It states that "the following items of gross income
shall be treated as gross income from sources within the Philippines." It does not state or imply that an
income not listed therein is necessarily from sources outside the Philippines.

 As to appellants' contention that reinsurance premiums constitute "gross receipts" instead of "gross income",
not subject to income tax, suffice it to say that, "gross receipts" of amounts that do not constitute return of
capital, such as reinsurance premiums, are part of the gross income of a taxpayer. At any rate, the tax
actually collected in this case was computed not on the basis of gross premium receipts but on the net
premium income, that is, after deducting general expenses, payment of policies and taxes.

ISSUE#2: whether or not reinsurance premiums are subject to withholding tax under Section 54 in relation to Section
53 of the Tax Code.

HELD: Yes

RATIO:

Subsection (b) of Section 53 subjects to withholding tax the following: interest, dividends, rents, salaries, wages, premiums,
annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and
income of any non-resident alien individual not engaged in trade or business within the Philippines and not having any office or
place of business therein. Section 54, by reference, applies this provision to foreign corporations not engaged in trade or business
in the Philippines.

 Appellants maintain that reinsurance premiums are not "premiums" at all and that they are not within the
scope of "other fixed or determinable annual or periodical gains, profits, and income"; that, therefore, they
are not items of income subject to withholding tax.

 SC disagrees with the contention. Since Section 53 subjects to withholding tax various specified income,
among them, "premiums", the generic connotation of each and every word or phrase composing the
enumeration in Subsection (b) thereof is income. Perforce, the word "premiums", which is neither qualified
nor defined by the law itself, should mean income and should include all premiums constituting income,
whether they be insurance or reinsurance premiums.
  Assuming that reinsurance premiums are not within the word "premiums" in Section 53, still they may be
classified as determinable and periodical income under the same provision of law. Section 199 of the
Income Tax Regulations defines fixed, determinable, annual and periodical income:

 Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is
determinable whenever there is a basis of calculation by which the amount to be paid may be
ascertained.The income need not be paid annually if it is paid periodically. That the length of time during
which the payments are to be made may be increased or diminished in accordance with someone's will or
with the happening of an event does not make the payments any the less determinable or periodical. ...

 Reinsurance premiums, therefore, are determinable and periodical income: determinable, because they can
be calculated accurately on the basis of the reinsurance contracts; periodical, inasmuch as they were
earned and remitted from time to time.

 Appellants' claim for refund, as stated, invoked a ruling of the CIR cited rulings attempting to show that the
prevailing administrative interpretation of Sections 53 and 54 of the Tax Code exempted from withholding
tax reinsurance premiums ceded to non-resident foreign insurance companies. It is asserted that since
Sections 53 and 54 were "substantially re-enacted" by Republic Acts 1065 , 1291, 1505, and 2343, when the
said administrative rulings prevailed, the rulings should be given the force of law under the principle of
legislative approval by re-enactment.

CIR vs British Overseas Airways Corp

Facts:
 BOAC is a 100% British Government owned corporation, organized and existing under
the laws of the UK. It operates air transportation services and sells tickets over the
routes of other airlines.
 During the disputed period wherein it was assessed deficiency income tax, it did not
have landing rights in the Philippines, nor did it have a CPCN. As such it did not carry
passengers or cargo to or from the Philippines.
 However it had a general sales agent in the PH, Wamer Barnes and Company, which
sold tickets on behalf of BOAC which covered passengers and cargo.
 May 7, 1968 CIR assessed BOAC the amount of 2.5M for deficiency income covering
years 1959-1963. This amount was lowered, after subsequent investigation, to 858K
which BOAC paid under protest.
o BOAC then filed a claim for refund which was denied by CIR. Filed a petition
with the Tax Court.
 November 17, 1971 BOAC was assessed a deficiency income tax, interest, and penalty
for fiscal years 1968-1969 to 1970-1971 in the aggregate amount of 549K.
 Tax court held that BOAC should be credited for the amount of 848K and that CIR
should cancel the deficiency income tax. Its reasoning was that income from
transportation is income from services rendered. Since BOAC did not actually perform
any transportation services within the Philippines there was nothing to tax. It further
stated that where the service is rendered determines the source.

Issues Ratio:
  WON BOAC is a resident foreign corporation or if it is a non-resident foreign
corporation(If foreign would have to pay income taxes at a rate of 35% of gross)-
Resident Foreign Corporation
 WON the ticket sales made in the Philippines, despite BOAC having no landing rights,
constitutes income from PH sources and are thusly taxable? Yes

Ratio

BOAC is a resident foreign corporation. The definition of the same is given under
Section 20 of the 1977 Tax Code:

(h) the term resident foreign corporation engaged in trade or business within the
Philippines or having an office or place of business therein.

While there is no specific criterion of what constitutes doing or engaging in or

transacting business, the term implies a certain continuity and just one of temporary character.
Furthermore the work done must be for commercial gain or the furtherance of the purpose and
objectives of the business organization.

The court looked into the activities of the General Sales agent, which included selling
and issuing tickets, breaking down whole trips into a series of trips (with each partitioned trip
in the series corresponding to a different airline), and receiving fare for the entire trip. Looking
at the activities of the general sales agent the court had no doubt that BOAC was engaged in
business through a local agent.

The court also ruled that the income derived from such sale of tickets was taxable.
They ruled that regardless of the organization of BOAC, it was sufficient that income derived
from activities within the Philippines. They noted that every part of the transaction was
performed within the Philippines and as such enjoyed protection accorded by the Philippine
Government. They ruled that since it enjoyed such protection, it should also share in the
burden of supporting the government through payment of taxes.

A. SORIANO Y CIA. v. COLLECTOR OP INTERNAL REVENUE, GR No. L-5896, 1955-08-31

Facts:
It appears that in the year 1947, petitioner was engaged in the business of selling surplus goods
acquired from the Foreign Liquidation Commission pursuant tovan agreement with the United States
Government whereby petitioner undertook to rehabilitate the Veterans
Administration Building (formerly Heacock Building) for and in consideration of over a million
pesos worth of surplus goods. Part of the surplus goods consisted of tractors which were then in the
various U. S. military bases or depots in the Philippines. The petitioner had yards... known as "Sta.
Mesa Yard" and "Pieco Yard" located in Manila, where some of the surplus goods were stored, and
those which were defective reconditioned.
In January, 1947, the United Africa Co., Ltd. sent its representative, Hugh Watson Gibson, to the
Philippines to look into the availability of tractors for sale in the Philippines. Gibson learned of
petitioner's business and contracted to buy tractors from the latter, to be... delivered f.a.s. (free
alongside ship), Manila, in good working condition and capable of running off lighters under their
own power. A tractor expert, Mr. Tex Taylor, was employed by the foreign company to select,
inspect and test the tractors before delivery.
Tex Taylor went to the different military bases, took the serial numbers of the tractors which he
wanted, and I gave the list thereof to the petitioner, who then secured from the Foreign Liquidation
Commission the purchase invoices and other documents for the immediate... release of the tractors.
The tractors were then removed by petitioner to its Pieco Yard, where they were tested by Tex
Taylor. Those found to be in good condition were approved by Taylor, wherefore petitioner
presented to him the sales invoices for his signature, stamping his... approval thereon. Twenty-four of
the tractors were found defective and so were brought to petitioner's Sta. Mesa Yard for
reconditioning. Upon approval of each invoice, the same was presented by petitioner to the
Philippine Refining Company, Inc., an affiliate of the foreign... buyer, for payment of the purchase
price. The Philippine Refining Co. would in turn notify the National City Bank of New York and the
Hongkong and Shanghai Banking Corporation, Manila, where the United Africa Co. had dollar
deposits, to make payment of petitioner's invoices. The... tractors were delivered by petitioner to the
pier in Manila by means of barges as soon as notice was received from the representative of its
foreign buyer that a carrying vessel was ready. On June 24 and August 26, 1947, the Philippine
Refining Co., Inc. shipped the 57 tractors... acquired from petitioner from the port of Manila to
United Africa Co., Ltd. at Dares Salaem, East Africa. The total value of the tractors was P757,000.
However, due to certain defects of some of them upon reaching Africa, the sum of P4,959.19 was
reimbursed by petitioner to its... foreign buyer by credit memo.
Issues:
whether or not petitioner is liable for the payment of percentage or sales tax on its gross sales of the
57 tractors in question to the United Africa Co., Ltd. under the provisions of Sec. 186 of the National
Internal Revenue Code.
"Section 186, Percentage tax on sales of other articles. There is levied, assessed, and collected once
only on every original sale, barter, exchange, and similar transaction intended to transfer ownership
of, or title to, the articles not enumerated in... sections 184 and 185, a tax equivalent to five per
centum of the gross selling price or gross value in money of the articles so sold, bartered, exchanged,
or transferred, such tax to be paid by the manufacturer, producer, or importer; * * *."
Ruling:
Under the above provisions, petitioner's liability would thus depend on first, whether or not it was an
importer of the 57 tractors in question, and second, whether it made an original sale thereof in the
Philippines.
The rule is that where... the contract is to deliver goods f.a.s, the property passes on delivery at the
wharf or the dock (II Williston on Sales, pp. 120-121; 46 Am. Jur. 608-609). Otherwise stated,
delivery to the carrier is delivery to the buyer, (Behn, Meyer & Co., Ltd. vs. Yangco, 38
Phil., 602; 46 Am. Jur. 605). True that this rule yields to evidence of a contrary intent between the
parties, but there is here no proof to show that petitioner and its foreign buyer intended otherwise,
that, is, that delivery and the passing of title to its buyer should take... place right in the army bases
where the tractors were located. On the contrary, petitioner itself has admitted that Tex Taylor (who
is no alleged to have accepted delivery of the tractors in behalf of the United Africa Co., Ltd.) has no
power or authority whatever to do so.
Other undisputed facts in the record also force the conclusion that title to the tractors in question
passed to petitioner's buyer not at the bases, but only at pier, Manila. First, it was petitioner who paid
for the delivery charges from the different bases to the pier/... pursuant to the tax in "fob" or "f.a.s."
sales that "the seller pays all charges and is subject to risk until the goods are placed alongside the
'vessel' (Williston, supra). Second, the tractors were described in petitioner's invoices (Vol. I,
Records, pp. 65-70) as... bearing certain numbers followed by the phrase "Our Unit Sta. Mesa" or
"Our Unit Pieco", showing that the tractors were first brought to petitioner's yards and numbered
accordingly, in the same way that all goods found and stored in these yards were numbered, and it
was only... after they had passed petitioner's yards that they were delivered to the buyer. Third, two
of petitioner's invoices (Records, I, pp. 70-71) state that the tractors were inspected and accepted at
Pieco Yard and/or Sta. Mesa Yard, which disproves petitioner's contention that Tex
Taylor tested and approved of them right in the bases. Fourth, petitioner's own witness Epimaco
Gonzales admitted that it was only at Pieco Yard that Taylor inspected and tested the tractors (t.s.n.
9-10).
Finally, petitioner urges that the repeal of the consignment or "export tax" under Sec. 187 of the
Internal Revenue Code shows the intention of the legislature to exempt all exports from tax.
It should not be forgotten that the consignment tax formerly imposed on exports by section 187 of the
Tax Code (now repealed by R. A. 41) is different from the sales tax imposed by Art. 186, which has
not been repealed.
The distinction between the two kinds of tax was pointed... out by this Court in the case of Vegetable
Oil Corp. vs. Trinidad, 45 Phil., 834-835, where we held:
"That the consignment tax is not a sales tax is, however, too obvious for argument, the fact that it is
provided for in the same section as the sales tax does not necessarily make it so. There is all the
difference in the word between a consignment and a sale. As stated by... counsel for the appellee, the
tax on consignment Is a privilege tax pure and simple; it is a tax on the business of consigning
commodities abroad from these glands. * * * If the tax were one on sales we Would readily agree
that the sales, in order to be taxable in the
Philippines must be consummated there."
Petitioner contends that to tax one who sells goods intended for export would be to nullify the
legislative intent behind the repeal of the tax on consignments abroad, which is to encourage exports.
The argument is fallacious. The law subjects to the payment of the sales tax... not the buyer who
intends to exports what he buys, but the seller, because such sale is domestic and therefore liable for
the payment of sales tax in this country.

Bachrach vs Seifert
Facts: The deceased E. M. Bachrach, who left no forced heir except his widow Mary McDonald
Bachrach, in his last will and testament made various legacies in cash and willed the remainder
of his estate. The estate of E. M. Bachrach, as owner of 108,000 shares of stock of the Atok-Big
Wedge Mining Co., Inc., received from the latter 54,000 shares representing 50 per cent stock
dividend on the said 108,000 shares. On June 10, 1948, Mary McDonald Bachrach, as
usufructuary or life tenant of the estate, petitioned the lower court to authorize the Peoples Bank
and Trust Company, as administrator of the estate of E. M. Bachrach, to transfer to her the said
54,000 shares of stock dividend by indorsing and delivering to her the corresponding certificate
of stock, claiming that said dividend, although paid out in the form of stock, is fruit or income
and therefore belonged to her as usufructuary or life tenant. Sophie Siefert and Elisa Elianoff,
legal heirs of the deceased, opposed said petition on the ground that the stock dividend in
question was not income but formed part of the capital and therefore belonged not to the
usufructuary but to the remainderman. While appellants admit that a cash dividend is an income,
they contend that a stock dividend is not, but merely represents an addition to the invested
capital. Issue: Whether or not a dividend is an income and whether it should go to the
usufructuary. Held: The usufructuary shall be entitled to receive all the natural, industrial, and
civil fruits of the property in usufruct. The 108,000 shares of stock are part of the property in
usufruct. The 54,000 shares of stock dividend are civil fruits of the original investment. They
represent profits, and the delivery of the certificate of stock covering said dividend is equivalent
to the payment of said profits. Said shares may be sold independently of the original shares, just
as the offspring of a domestic animal may be sold independently of its mother. If the dividend be
in fact a profit, although declared in stock, it should be held to be income. A dividend, whether in
the form of cash or stock, is income and, consequently, should go to the usufructuary, taking into
consideration that a stock dividend as well as a cash dividend can be declared only out of profits
of the corporation, for if it were declared out of the capital it would be a serious violation of the
law. Under the Massachusetts rule, a stock dividend is considered part of the capital and belongs
to the remainderman; while under the Pennsylvania rule, all earnings of a corporation, when
declared as dividends in whatever form, made during the lifetime of the usufructuary, belong to
the latter. The Pennsylvania rule is more in accord with our statutory laws than the
Massachusetts rule.

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS,

COURT OF TAX APPEALS and A. SORIANO CORP., respondents. DECISION MARTINEZ,
J.:

FACTS:
Don Andres Soriano, a citizen and resident of the United States, formed the corporation
A. Soriano Y Cia, predecessor of ANSCOR, which is wholly owned and controlled by the family
of Don Andres, who are all non-resident aliens. When Don Andres died he has a total
shareholdings of 185,154 shares; 50,495 of which are original issues and the balance of 134,659
shares as stock dividend declarations. Pursuant to a Board Resolution, ANSCOR redeemed a
total of 108,000 common shares from the Don Andres estate. ANSCORs business purpose for
both redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce
the company’s foreign exchange remittances in case cash dividends are declare. After examining
ANSCORs books of account and records, it was assessed for deficiency withholding tax-at-
source by the BIR, pursuant to Sections 53 and 54 of the 1939 Revenue Code for the transactions
of exchange and redemption of stocks. ANSCOR claimed that it availed of the tax amnesty under
Presidential Decree (P.D.) 23 which were amended by P.D.s 67 and 157, hence, is not liable to
pay the deficiency tax. However, petitioner-CIR ruled that the invoked decrees do not cover
Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR
was assessed. ANSCORs subsequent protest on the assessments was denied by petitioner.

ISSUE:
Whether or not ANSCORs redemption of stocks from its stockholder as well as the
exchange of common with preferred shares can be considered as essentially equivalent to the
distribution of taxable dividend, making the proceeds thereof taxable under the provisions the
Section 83(b) of the Tax Code.

RULING:
Yes. Stock dividends represent capital and do not constitute income to its recipient. The
mere issuance thereof is not yet subject to income tax as they are only an increase in value of
capital investment. Stock dividends issued by the corporation are considered unrealized gain, and
cannot be subjected to income tax until that gain has been realized. Before the realization, stock
dividends are representation of an interest in the corporate properties. As capital, it is not yet
subject to income tax. However, under Section 83(b) of the Tax Code, if a corporation cancels or
redeems stock issued as a dividend at such time and in such manner as to make the distribution
and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a
taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent it represents a distribution of earnings or profits
accumulated after March 1, 1913. For the exempting clause of Section 83(b) to apply, it is
indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock
dividends and (c) the time and manner of the transaction makes it essentially equivalent to a
distribution of taxable dividends. Of these, the most important is the third. The test of taxability
under the exempting clause of Section 83(b) is, whether income was realized through the
redemption of stock dividends. The redemption converts into money the stock dividends which
become a realized profit or gain and consequently, the stockholders separate property. Profits
derived from the capital invested cannot escape income tax. As realized income, the proceeds of
the redeemed stock dividends shall be subject to income tax. Otherwise, to rule that the said
proceeds are exempt from income tax when the redemption is supported by legitimate business
reasons would defeat the very purpose of imposing tax on income. The three elements in the
imposition of income tax are: (1) there must be gain or profit, (2) that the gain or profit is
realized or received, actually or constructively,[108] and (3) it is not exempted by law or treaty
from income tax The ruling in the American cases cited in the instant case and relied upon by
ANSCOR that the redeemed shares are the equivalent of dividend only if the shares were not
issued for genuine business purposes or the redeemed shares have been issued by a corporation
bona fide bears no relevance in determining the non-taxability of the proceeds of redemption.
ANSCOR, relying heavily and applying said cases, argued that so long as the redemption is
supported by valid corporate purposes the proceeds are not subject to tax. The Court, after
considering the manner and the circumstances by which the issuance and redemption of stock
dividends were made, concluded that the proceeds thereof are essentially considered equivalent
to a distribution of taxable dividends. As taxable dividend under Section 83(b), it is part of the
entire income subject to tax under Section 22 in relation to Section 21 of the 1939 Code.
Moreover, under Section 29(a) of said Code, dividends are included in gross income. As income,
it is subject to income tax which is required to be withheld at source.

PHILIPPINE AMERICAN LIFE INSURANCE COMPANY, INC., ET AL., v. HON. COURT OF TAX
APPEALS, AND THE
COMMISSIONER OF INTERNAL REVENUE
CA-G.R. SP No. 31283 25 April 1995

Doctrine:

The test of taxability is the ‘source’, and the source of an income is that activity which produced
the income.

Facts:

Petitioner Philippine American Life Insurance Co., Inc. (PHILAMLIFE), a domestic corporation
entered into a Management Services Agreement with American International Reinsurance Co.,
Inc. (AIRCO), a non-resident foreign corporation with principal place of business in Pembroke,
Bermuda whereby, effective January 1, 1972, for a fee of not exceeding $250,000.00 per
annum, AIRCO shall perform for PHILAMLIFE various management services.

On September 30, 1978, AIRCO merged with petitioner

American International Group, Inc. (AIGI) with the latter as the surviving corporation and
successor-in-interest in AIRCO’s Management Services Agreement with PHILAMLIFE.

On November 18, 1980, respondent Commission of Internal Revenue (CIR) issued in favour of
PHILAMLIFE Tax Credit Memo in the amount of Php643,125.00 representing erroneous
payment of withholding tax at source on remittances to AIGI for services rendered abroad in
1979.

On the basis of the said issuance of tax credit, PHILAMLIFE, through a letter dated March 21,
1981, filed with CIR a claim for refund of the second erroneous tax payment of Php643,125.00
which was made on December 16, 1980. Another letter dated July 6, 1982 was sent wherein
PHILAMLIFE alleged that the claim for refund of the amount paid in 1980 is exactly the same
subject matter as in the previous claim for refund in 1979.

Without waiting for CIR to resolve the claim, petitioners filed with the Court of Tax Appeals
(CTA) on July 29, 1982 the petition docketed as CTA Case No. 3540, seeking said refund.

During pendency of said case, respondent denied PHILAMLIFE’s claim for refund of
Php643,125.00 as withholding tax at source for 1980. Respondent also cancelled the tax credit
memo in the amount of Php643,125.00 previously issued to PHILAMLIFE on November 18,
1980 and requested the latter to pay the amount of Php643,125.00 as deficiency withholding
tax at source for 1979 plus increments.

Without protesting the assessment, petitioners filed a petition with CTA on June 14, 1985,
docketed as CTA Case No. 3943, seeking the annulment of said assessment.

After trial on the merits, respondent tax court rendered the decision dated March 10, 1993
denying both petitions for review and subsequent motions for reconsiderations.

Both parties filed motion for reconsideration on the March 10, 1993 decision wherein the
respondent tax court issued a resolution dated May 19, 1993 which modified the dispositive
portion of the said decision ordering the PHILAMLIFE to pay respondent the amount of
Php643,125.00 with interest at the rate of twenty per centum (20%) per annum from March 9,
1981 until paid.

Issues:

1. Whether or not compensation for advisory services admittedly performed abroad by the
personnel of a nonresident foreign corporation not doing business in the Philippines are
subject to Philippine withholding income
tax – YES

2. Whether or not respondent CIR is barred by prescription, laches, estoppel, or equitable

considerations in cancelling the previous approval of petitioners claim for refund more than
5 years thereafter, after it has determined, after investigation, that the advisory services
were rendered or performed abroad by the personnel of AIGI, a non-resident foreign
corporation not doing business in the Philippines – NO

3. Whether or not respondent tax court can amend its decision on a motion for
reconsideration by respondent Commissioner, ordering petitioner PHILAMLIFE to pay
Php643,125.00 with interest at 20% per annum until paid on the presumption that it has
utilized the tax credit memo already issued and without evidence being presented of actual
usage of the tax credit memo – YES

Ratio:

1. In our jurisprudence, the test of taxability is the ‘source’, and the source of an income is that
activity which produced the income. It is not the presence of any property from which one
derives rentals and royalties that is controlling, but rather as expressed under the expanded
meaning of “royalties” in Section 37 (a) of National Internal Revenue Code, it includes
“royalties for the supply of scientific, technical, industrial, or commercial knowledge or
information; and the technical advice, assistance or services rendered in connection with
 the technical management and administration of any scientific, industrial or commercial
undertaking, venture, project or scheme”.

The Management Services Agreement falls under the expanded meaning of “royalties” as it
provides for the supply of a nonresident foreign corporation of technical and commercial
information, knowledge, advice, assistance or services in connection with technical
management or administration of an insurance business – a commercial undertaking.
Therefore, the income derived for the services performed by AIGI for PHILAMLIFE under the
said agreement contract shall be considered as income from services within the Philippines.
AIGI, being a non-resident foreign corporation not engage in trade and business in the
Philippines shall pay tax equal to 35% of the gross income received during each taxable year
from all sources within the Philippines as interest, dividends, rents, royalties (including
remuneration for technical services), salaries, premiums, annuities, emoluments, or other fixed
or determinable annual, periodical or casual gains, profits and income.

On the second issue, this Court believes that the rule on prescription of assessment and the
filing of formal protest will not apply.

Pursuant to Section 229 of NIRC, no such suit or proceeding shall be begun after the expiration
of two years from the date of payment of tax penalty regardless of any supervening cause that
may arise after payment. Although counting from the original date of payment of the tax on
December 3, 1979, the filing of the instant Petition for Review on June 14, 1985 would appear
to have been filed out of time, nevertheless, justice and equity demand that the period during
which respondent approved the herein claim for refund up to the time it was subsequently
cancelled should be deducted from the counting of the two years prescriptive period. By
deducting the period when Petitioner received the tax credit memo on March 9, 1981 to May
15, 1985 when the same was cancelled by the respondent only one year and four months had
elapsed from the two year period of prescription when petitioner filed CTA 3943 on June 4,
1985.

In like manner, CIR’s failure to raise before the CTA the issue relating to the real party in
interest to claim the refund cannot, and should not, prejudice the government. It is axiomatic
that the government can never be in estoppel, particularly in matters involving taxes. The
errors or omissions of certain administrative officers should never be allowed to jeopardize the
government’s financial position.

On the third issue, this Court finds no error on the part of respondent tax court in amending its
March 10, 1993 decision acting upon timely motion for reconsiderations filed by both
petitioner and respondent. Said decision having not attained its finality, the same may still be
amended, corrected or modified by the respondent court.

Moreover, it has been the long standing policy and practice of this Court to respect the
conclusions of quasi-judicial agencies, such as the Court of tax Appeals which, by nature of its
function, is dedicated exclusively to the study and consideration of tax problems and has
necessarily developed an expertise on the subject, unless there has been an abuse or
improvident exercise of authority or discretion, the decision of respondent court, affirming the
decision of the Court of Tax Appeals, must consequently be upheld.