SECOND DIVISION

[G.R. No. L-26284. October 9, 1986.]

OMAS CALASANZ, ET AL., Petitioners, v. THE COMMISSIONER OF INTERNAL

REVENUE and the COURT OF TAX APPEALS, Respondents.

DECISION
FERNAN, J.:

Appeal taken by Spouses Tomas and Ursula Calasanz from the decision of the Court of Tax
Appeals in CTA No. 1275 dated June 7, 1966, holding them liable for the payment of P3,561.24
as deficiency income tax and interest for the calendar year 1957 and P150.00 as real estate
dealers fixed tax.

Petitioner Ursula Calasanz inherited from her father Mariano de Torres an agricultural land
located in Cainta, Rizal, containing a total area of 1,678,000 square meters. In order to liquidate
her inheritance, Ursula Calasanz had the land surveyed and subdivided into lots. Improvements,
such as good roads, concrete gutters, drainage and lighting system, were introduced to make the
lots saleable. Soon after, the lots were sold to the public at a
profit.chanroblesvirtuallawlibrary:red

In their joint income tax return for the year 1957 filed with the Bureau of Internal Revenue on
March 31, 1958, petitioners disclosed a profit of P31,060.06 realized from the sale of the
subdivided lots, and reported fifty per centum thereof or P15,530.03 as taxable capital gains.

Upon an audit and review of the return this filed, the Revenue Examiner adjudged petitioners
engaged in business as real estate dealers, as defined in Section 194 [s] 1 of the National
Internal Revenue Code, required them to pay the real estate dealers tax 2 and assessed a
deficiency income tax on profits derived from the sale of the lots based on the rates for ordinary
income.

On September 29, 1962, petitioners received from respondent Commissioner of Internal

Revenue:chanrob1es virtual 1aw library

a. Demand No. 90-B-032293-57 in the amount of P160.00 representing real estate dealers fixed
tax of P150.00 and P10.00 compromise penalty for late payment; and
b. Assessment No. 90-5-35699 in the amount of P3,561.24 as deficiency income tax on ordinary
gain of P3,018.00 plus interest of P543.24.

On October 17, 1962, petitioners filed with the Court of Tax Appeals a petition for review
contesting the aforementioned assessments.

On June 7, 1966, the Tax Court upheld the respondent Commissioner except for that portion of
the assessment regarding the compromise penalty of P10.00 for the reason that in this
jurisdiction, the same cannot be collected in the absence of a valid and binding compromise
agreement.chanrobles virtualawlibrary chanrobles.com:chanrobles.com.ph

Hence, the present appeal.

The issues for consideration are:chanrob1es virtual 1aw library

a. Whether or not petitioners are real estate dealers liable for real estate dealers fixed tax; and

b. Whether the gains realized from the sale of the lots are taxable in full as ordinary income or
capital gains taxable at capital gain rates.

The issues are closely interrelated and will be taken jointly.

Petitioners assail their liabilities as "real estate dealers" and seek to bring the profits from the
sale of the lots under Section 34 [b] [2] 3 of the Tax Code.

The theory advanced by the petitioners is that inherited land is a capital asset within the
meaning of Section 34[a] [1] of the Tax Code and that an heir who liquidated his inheritance
cannot be said to have engaged in the real estate business and may not be denied the preferential
tax treatment given to gains from sale of capital assets, merely because he disposed of it in the
only possible and advantageous way.

Petitioners averred that the tract of land subject of the controversy was sold because of their
intention to effect a liquidation. They claimed that it was parcelled out into smaller lots because
its size proved difficult, if not impossible, of disposition in one single transaction. They pointed
out that once subdivided, certainly, the lots cannot be sold in one isolated transaction,
Petitioners, however, admitted that roads and other improvements were introduced to facilitate
its sale. 4

On the other hand, respondent Commissioner maintained that the imposition of the taxes in
question is in accordance with law since petitioners are deemed to be in the real estate business
for having been involved in a series of real estate transactions pursued for profit. Respondent
argued that property acquired by inheritance may be converted from an investment property to a
business property if, as in the present case, it was subdivided, improved, and subsequently sold
and the number, continuity and frequency of the sales were such as to constitute "doing
business." Respondent likewise contended that inherited property is by itself neutral and the fact
that the ultimate purpose is to liquidate is of no moment for the important inquiry is what the
taxpayer did with the property. Respondent concluded that since the lots are ordinary assets, the
profits realized therefrom are ordinary gains, hence taxable in full.

We agree with the Respondent.

The assets of a taxpayer are classified for income tax purposes into ordinary assets and capital
assets. Section 34]a] [1] of the National Internal Revenue Code broadly defines capital assets as
follows:chanrobles virtualawlibrary chanrobles.com:chanrobles.com.ph

" [1] 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."cralaw
virtua1aw library

The statutory definition of capital assets is negative in nature. 5 If the asset is not among the
exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary
assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain
or an ordinary gain depending on the kind of asset involved in the transaction.

However, there is no rigid rule or fixed formula by which it can be determined with finality
whether property sold by a taxpayer was held primarily for sale to customers in the ordinary
course of his trade or business or whether it was sold as a capital asset. 6 Although several
factors or indices 7 have been recognized as helpful guides in making a determination, none of
these is decisive; neither is the presence nor the absence of these factors conclusive. Each case
must in the last analysis rest upon its own peculiar facts and circumstances. 8

Also a property initially classified as a capital asset may thereafter be treated as an ordinary
asset if a combination of the factors indubitably tend to show that the activity was in furtherance
of or in the course of the taxpayers trade or business. Thus, a sale of inherited real property
usually gives capital gain or loss even though the property has to be subdivided or improved or
both to make it salable. However, if the inherited property is substantially improved or very
actively sold or both it may be treated as held primarily for sale to customers in the ordinary
course of the heirs business. 9

Upon an examination of the facts on record, We are convinced that the activities of petitioners
are indistinguishable from those invariably employed by one engaged in the business of selling
real estate.

One strong factor against petitioners contention is the business element of development which
is very much in evidence. Petitioners did not sell the land in the condition in which they
acquired it. While the land was originally devoted to rice and fruit trees, 10 it was subdivided
into small lots and in the process converted into a residential subdivision and given the name
Don Mariano Subdivision. Extensive improvements like the laying out of streets, construction
of concrete gutters and installation of lighting system and drainage facilities, among others,
were undertaken to enhance the value of the lots and make them more attractive to prospective
buyers. The audited financial statements 11 submitted together with the tax return in question
disclosed that a considerable amount was expended to cover the cost of improvements. As a
matter of fact, the estimated improvements of the lots sold reached P170,028.60 whereas the
cost of the land is only P4,742.66. There is authority that a property ceases to be a capital asset
if the amount expended to improve it is double its original cost, for the extensive improvement
indicates that the seller held the property primarily for sale to customers in the ordinary course
of his business. 12

Another distinctive feature of the real estate business discernible from the records is the
existence of contracts receivables, which stood at P395,693.35 as of the year ended December
31, 1957. The sizable amount of receivables in comparison with the sales volume of
P446,407.00 during the same period signifies that the lots were sold on installment basis and
suggests the number, continuity and frequency of the sales. Also of significance is the
circumstance that the lots were advertised 13 for sale to the public and that sales and collection
commissions were paid out during the period in question.

Petitioners, likewise, urge that the lots were sold solely for the purpose of liquidation.

In Ehrman v. Commissioner, 14 the American court in clear and categorical terms rejected the
liquidation test in determining whether or not a taxpayer is carrying on a trade or business. The
court observed that the fact that property is sold for purposes of liquidation does not foreclose a
determination that a "trade or business" is being conducted by the seller. The court enunciated
further:

"We fail to see that the reasons behind a persons entering into a business whether it is to
make money or whether it is to liquidate should be determinative of the question of whether
or not the gains resulting from the sales are ordinary gains or capital gains. The sole question is
were the taxpayers in the business of subdividing real estate? If they were, then it seems
indisputable that the property sold falls within the exception in the definition of capital assets .
that is, that it constituted `property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business."

Additionally, in Home Co., Inc. v. Commissioner, 15 the court articulated on the matter in this
wise:jgc:

"One may, of course, liquidate a capital asset. To do so, it is necessary to sell. The sale may be
conducted in the most advantageous manner to the seller and he will not lose the benefits of the
capital gain provision of the statute unless he enters the real estate business and carries on the
sale in the manner in which such a business is ordinarily conducted. In that event, the
liquidation constitutes a business and a sale in the ordinary course of such a business and the
preferred tax status is lost."
In view of the foregoing, We hold that in the course of selling the subdivided lots, petitioners
engaged in the real estate business and accordingly, the gains from the sale of the lots are
ordinary income taxable in full.

WHEREFORE, the decision of the Court of Tax Appeals is affirmed. No costs.

SO ORDERED.
G.R. No. L-24248 July 31, 1974
ANTONIO TUASON, JR., petitioner,
vs.
JOSE B. LINGAD, as Commissioner of Internal Revenue, respondent.
CASTRO, J.:p
In this petition for review of the decision of the Court of Tax Appeals in CTA Case 1398, the
petitioner Antonio Tuason, Jr. (hereinafter referred to as the petitioner) assails the Tax Court's
conclusion that the gains he realized from the sale of residential lots (inherited from his mother)
were ordinary gains and not gains from the sale of capital assets under section 34(1) of the
National Internal Revenue Code.
The essential facts are not in dispute.
In 1948 the petitioner inherited from his mother several tracts of land, among which were two
contiguous parcels situated on Pureza and Sta. Mesa streets in Manila, with an area of 318 and
67,684 square meters, respectively.
When the petitioner's mother was yet alive she had these two parcels subdivided into twenty-
nine lots. Twenty-eight were allocated to their then occupants who had lease contracts with the
petitioner's predecessor at various times from 1900 to 1903, which contracts expired on
December 31, 1953. The 29th lot (hereinafter referred to as Lot 29), with an area of 48,000
square meters, more or less, was not leased to any person. It needed filling because of its very
low elevation, and was planted to kangkong and other crops.
After the petitioner took possession of the mentioned parcels in 1950, he instructed his attorney-
in-fact, J. Antonio Araneta, to sell them.
There was no difficulty encountered in selling the 28 small lots as their respective occupants
bought them on a 10-year installment basis. Lot 29 could not however be sold immediately due
to its low elevation.
Sometime in 1952 the petitioner's attorney-in-fact had Lot 29 filled, then subdivided into small
lots and paved with macadam roads. The small lots were then sold over the years on a uniform
10-year annual amortization basis. J. Antonio Araneta, the petitioner's attorney-in-fact, did not
employ any broker nor did he put up advertisements in the matter of the sale thereof.
In 1953 and 1954 the petitioner reported his income from the sale of the small lots (P102,050.79
and P103,468.56, respectively) as long-term capital gains. On May 17, 1957 the Collector of
Internal Revenue upheld the petitioner's treatment of his gains from the said sale of small lots,
against a contrary ruling of a revenue examiner.
In his 1957 tax return the petitioner as before treated his income from the sale of the small lots
(P119,072.18) as capital gains and included only thereof as taxable income. In this return, the
petitioner deducted the real estate dealer's tax he paid for 1957. It was explained, however, that
the payment of the dealer's tax was on account of rentals received from the mentioned 28 lots
and other properties of the petitioner. On the basis of the 1957 opinion of the Collector of
Internal Revenue, the revenue examiner approved the petitioner's treatment of his income from
the sale of the lots in question. In a memorandum dated July 16, 1962 to the Commissioner of
Internal Revenue, the chief of the BIR Assessment Department advanced the same opinion,
which was concurred in by the Commissioner of Internal Revenue.
On January 9, 1963, however, the Commissioner reversed himself and considered the
petitioner's profits from the sales of the mentioned lots as ordinary gains. On January 28, 1963
the petitioner received a letter from the Bureau of Internal Revenue advising him to pay
deficiency income tax for 1957, as follows:
Net income per orig. investigation ............... P211,095.36
Add:
56% of realized profit on sale
of lots which was deducted in the
income tax return and allowed in
the original report of examination ................. 59,539.09
Net income per final investigation ................. P270,824.70
Less: Personal exemption ..................................... 1,800.00
Amount subject to tax ................................. P269,024.70
Tax due thereon .......................................... P98,551.00
Less: Amount already assessed .................... 72,199.00 Balance ......... P26,352.00
Add:
% monthly interest from
6-20-59 to 6-29-62 .................................... 4,742.36
TOTAL AMOUNT DUE AND
COLLECTIBLE ......................................... P31,095.36
The petitioner's motion for reconsideration of the foregoing deficiency assessment was denied,
and so he went up to the Court of Tax Appeals, which however rejected his posture in a decision
dated January 16, 1965, and ordered him, in addition, to pay a 5% Surcharge and 1% monthly
interest "pursuant to Sec. 51(e) of the Revenue Code."
Hence, the present petition.
The petitioner assails the correctness of the opinion below that as he was engaged in the
business of leasing the lots he inherited from his mother as well other real properties, his
subsequent sales of the mentioned lots cannot be recognized as sales of capital assets but of
"real property used in trade or business of the taxpayer." The petitioner argues that (1) he is not
the one who leased the lots in question; (2) the lots were residential, not commercial lots; and
(3) the leases on the 28 small lots were to last until 1953, before which date he was powerless to
eject the lessees therefrom.
The basic issue thus raised is whether the properties in question which the petitioner had
inherited and subsequently sold in small lots to other persons should be regarded as capital
assets.
1. The National Internal Revenue Code (C.A. 466, as amended) defines the term "capital assets"
as follows:
(1) 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.
As thus defined by law, the term "capital assets" includes all the properties of a taxpayer
whether or not connected with his trade or business, except: (1) stock in trade or other property
included in the taxpayer's inventory; (2) property primarily for sale to customers in the ordinary
course of his trade or business; (3) property used in the trade or business of the taxpayer and
subject to depreciation allowance; and (4) real property used in trade or business. 1 If the
taxpayer sells or exchanges any of the properties above-enumerated, any gain or loss relative
thereto is an ordinary gain or an ordinary loss; the gain or loss from the sale or exchange of all
other properties of the taxpayer is a capital gain or a capital loss. 2
Under section 34(b) (2) of the Tax Code, if a gain is realized by a taxpayer (other than a
corporation) from the sale or exchange of capital assets held for more than twelve months, only
50% of the net capital gain shall be taken into account in computing the net income.
The Tax Code's provision on so-called long-term capital gains constitutes a statute of partial
exemption. In view of the familiar and settled rule that tax exemptions are construed
in strictissimi juris against the taxpayer and liberally in favor of the taxing authority, 3 the field
of application of the term it "capital assets" is necessarily narrow, while its exclusions must be
interpreted broadly. 4 Consequently, it is the taxpayer's burden to bring himself clearly and
squarely within the terms of a tax-exempting statutory provision, otherwise, all fair doubts will
be resolved against him. 5 It bears emphasis nonetheless that in the determination of whether a
piece of property is a capital asset or an ordinary asset, a careful examination and weighing of
all circumstances revealed in each case must be made. 6
In the case at bar, after a thoroughgoing study of all the circumstances relevant to the resolution
of the issue raised, this Court is of the view, and so holds, that the petitioner's thesis is bereft of
merit.
When the petitioner obtained by inheritance the parcels in question, transferred to him was not
merely the duty to respect the terms of any contract thereon, but as well the correlative right to
receive and enjoy the fruits of the business and property which the decedent had established and
maintained. 7 Moreover, the record discloses that the petitioner owned other real properties
which he was putting out for rent, from which he periodically derived a substantial income, and
for which he had to pay the real estate dealer's tax (which he used to deduct from his gross
income). 8 In fact, as far back as 1957 the petitioner was receiving rental payments from the
mentioned 28 small lots, even if the leases executed by his deceased mother thereon expired in
1953. Under the circumstances, the petitioner's sales of the several lots forming part of his
rental business cannot be characterized as other than sales of non-capital assets.
The sales concluded on installment basis of the subdivided lots comprising Lot 29 do not
deserve a different characterization for tax purposes. The following circumstances in
combination show unequivocally that the petitioner was, at the time material to this case,
engaged in the real estate business: (1) the parcels of land involved have in totality a
substantially large area, nearly seven (7) hectares, big enough to be transformed into a
subdivision, and in the case at bar, the said properties are located in the heart of Metropolitan
Manila; (2) they were subdivided into small lots and then sold on installment basis (this manner
of selling residential lots is one of the basic earmarks of a real estate business); (3)
comparatively valuable improvements were introduced in the subdivided lots for the
unmistakable purpose of not simply liquidating the estate but of making the lots more saleable
to the general public; (4) the employment of J. Antonio Araneta, the petitioner's attorney-in-fact,
for the purpose of developing, managing, administering and selling the lots in question indicates
the existence of owner-realty broker relationship; (5) the sales were made with frequency and
continuity, and from these the petitioner consequently received substantial income periodically;
(6) the annual sales volume of the petitioner from the said lots was considerable, e.g.,
P102,050.79 in 1953; P103,468.56 in 1954; and P119,072.18 in 1957; and (7) the petitioner, by
his own tax returns, was not a person who can be indubitably adjudged as a stranger to the real
estate business. Under the circumstances, this Court finds no error in the holding below that the
income of the petitioner from the sales of the lots in question should be considered as ordinary
income.
2. This Court notes, however, that in ordering the petitioner to pay the deficiency income tax,
the Tax Court also required him to pay a 5% surcharge plus 1% monthly interest. In our opinion
this additional requirement should be eliminated because the petitioner relied in good faith upon
opinions rendered by no less than the highest officials of the Bureau of Internal Revenue,
including the Commissioner himself. The following ruling in Connell Bros. Co. (Phil.) vs.
Collector of Internal Revenue 9 applies with reason to the case at bar:
We do not think Section 183(a) of the National Internal Revenue Code is applicable. The same
imposes the penalty of 25% when the percentage tax is not paid on time, and contemplates a
case where the liability for the tax is undisputed or indisputable. In the present case the taxes
were paid, the delay being with reference to the deficiency, owing to a controversy as to the
proper interpretation if Circulars Nos. 431 and 440 of the office of respondent-appellee. The
controversy was generated in good faith, since that office itself appears to have formerly taken
the view that the inclusion of the words "tax included" on invoices issued by the taxpayer was
sufficient compliance with the requirements of said circulars. 10
ACCORDINGLY, the judgment of the Court of Tax Appeals is affirmed, except the portion
thereof that imposes 5% surcharge and 1% monthly interest, which is hereby set aside. No
costs.
[G.R. No. 125508. July 19, 2000]
CHINA BANKING CORPORATION, petitioner, vs. COURT OF APPEALS,
COMMISSIONER OF INTERNAL REVENUE and COURT OF TAX
APPEALS,respondents.
DECISION
VITUG, J.:
The Commissioner of Internal Revenue denied the deduction from gross income of "securities
becoming worthless" claimed by China Banking Corporation (CBC). The Commissioners
disallowance was sustained by the Court of Tax Appeals ("CTA"). When the ruling was
appealed to the Court of Appeals ("CA"), the appellate court upheld the CTA. The case is now
before us on a Petition for Review on Certiorari.
Sometime in 1980, petitioner China Banking Corporation made a 53% equity investment in the
First CBC Capital (Asia) Ltd., a Hongkong subsidiary engaged in financing and investment
with "deposit-taking" function. The investment amounted to P16,227,851.80, consisting of
106,000 shares with a par Value of P100 per share.
In the course of the regular examination of the financial books and investment portfolios of
petitioner conducted by Bangko Sentral in 1986, it was shown that First CBC Capital (Asia),
Ltd., has become insolvent. With the approval of Bangko Sentral, petitioner wrote-off as being
worthless its investment in First CBC Capital (Asia), Ltd., in its 1987 Income Tax Return and
treated it as a bad debt or as an ordinary loss deductible from its gross income.
Respondent Commissioner of internal Revenue disallowed the deduction and assessed
petitioner for income tax deficiency in the amount of P8,533,328.04, inclusive of surcharge,
interest and compromise penalty. The disallowance of the deduction was made on the ground
that the investment should not be classified as being "worthless" and that, although the
Hongkong Banking Commissioner had revoked the license of First CBC Capital as a "deposit-
taping" company, the latter could still exercise, however, its financing and investment
activities.Assuming that the securities had indeed become worthless, respondent Commissioner
of Internal Revenue held the view that they should then be classified as "capital loss," and not
as a bad debt expense there being no indebtedness to speak of between petitioner and its
subsidiary.
Petitioner contested the ruling of respondent Commissioner before the CTA. The tax court
sustained the Commissioner, holding that the securities had not indeed become worthless and
ordered petitioner to pay its deficiency income tax for 1987 of P8,533,328.04 plus 20% interest
per annum until fully paid. When the decision was appealed to the Court of Appeals, the latter
upheld the CTA. In its instant petition for review on certiorari, petitioner bank assails the CA
decision.
The petition must fail.
The claim of petitioner that the shares of stock in question have become worthless is based on a
Profit and Loss Account for the Year-End 31 December 1987, and the recommendationof
Bangko Sentral that the equity investment be written-off due to the insolvency of the
subsidiary. While the matter may not be indubitable (considering that certain classes of
intangibles, like franchises and goodwill, are not always given corresponding values in financial
statements[1], there may really be no need, however, to go of length into this issue since, even to
assume the worthlessness of the shares, the deductibility thereof would still be nil in this
particular case. At all events, the Court is not prepared to hold that both the tax court and the
appellate court are utterly devoid of substantial basis for their own factual findings.
Subject to certain exceptions, such as the compensation income of individuals and passive
income subject to final tax, as well as income of non-resident aliens and foreign corporations
not engaged in trade or business in the Philippines, the tax on income is imposed on the net
income allowing certain specified deductions from gross income to be claimed by the
taxpayer.Among the deductible items allowed by the National Internal Revenue Code ("NIRC")
are bad debts and losses.[2]
An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of
which results in either a capital gain or a capital loss. The gain or the loss is ordinary whenthe
property sold or exchanged is not a capital asset.[3] A capital asset is defined negatively in
Section 33(1) of the NIRC; viz:
(1) 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 twenty-nine; or real property used in the trade or business of the
taxpayer.
Thus, shares of stock; like the other securities defined in Section 20(t) [4] of the NIRC, would
be ordinary assets only to a dealer in securities or a person engaged in the purchase and
sale of, or an active trader (for his own account) in, securities. Section 20(u) of the NIRC
defines a dealer in securities thus:
"(u) The term 'dealer in securities' means a merchant of stocks or securities, whether an
individual, partnership or corporation, with an established place of business, regularly engaged
in the purchase of securities and their resale to customers; that is, one who as a merchant buys
securities and sells them to customers with a view to the gains and profits that may be derived
therefrom."
In the hands, however, of another who holds the shares of stock by way of an investment, the
shares to him would be capital assets. When the shares held by such investor become
worthless, the loss is deemed to be a loss from the sale or exchange of capital
assets. Section 29(d)(4)(B) of the NIRC states:
"(B) Securities becoming worthless. - If securities as defined in Section 20 become worthless
during the tax" year and are capital assets, the loss resulting therefrom shall, for the purposes of
his Title, be considered as a loss from the sale or exchange, on the last day of such taxable year,
of capital assets."
The above provision conveys that the loss sustained by the holder of the securities, which are
capital assets (to him), is to be treated as a capital loss as if incurred from a sale or exchange
transaction. A capital gain or a capital loss normally requires the concurrence of two
conditions for it to result: (1) There is a sale or exchange; and (2) the thing sold or exchanged is
a capital asset. When securities become worthless, there is strictly no sale or exchange but the
law deems the loss anyway to be "a loss from the sale or exchange of capital assets. [5]A similar
kind of treatment is given, by the NIRC on the retirement of certificates of indebtedness with
interest coupons or in registered form, short sales and options to buy or sell property where no
sale or exchange strictly exists.[6] In these cases, the NIRC dispenses, in effect, with the standard
requirement of a sale or exchange for the application of the capital gain and loss provisions of
the code.
Capital losses are allowed to be deducted only to the extent of capital gains, i.e., gains
derived from the sale or exchange of capital assets, and not from any other income of the
taxpayer.
In the case at bar, First CBC Capital (Asia), Ltd., the investee corporation, is a subsidiary
corporation of petitioner bank whose shares in said investee corporation are not intended for
purchase or sale but as an investment. Unquestionably then, any loss therefrom would be a
capital loss, not an ordinary loss, to the investor.
Section 29(d)(4)(A), of the NIRC expresses:
"(A) Limitations. - Losses from sales or exchanges of capital assets shall be allowed only to the
extent provided in Section 33."
The pertinent provisions of Section 33 of the NIRC referred to in the aforesaid Section 29(d)(4)
(A), read:
"Section 33. Capital gains and losses. -
x x x x x x x x x.
"(c) Limitation on capital losses. - Losses from sales or exchange of capital assets shall be
allowed only to the extent of the gains from such sales or exchanges. If a bank or trust
company incorporated under the laws of the Philippines, a substantial part of whose business is
the receipt of deposits, sells any bond, debenture, note, or certificate or other evidence of
indebtedness issued by any corporation (including one issued by a government or political
subdivision thereof), with interest coupons or in registered form, any loss resulting from such
sale shall not be subject to the foregoing limitation an shall not be included in determining the
applicability of such limitation to other losses.
The exclusionary clause found in the foregoing text of the law does not include all forms of
securities but specifically covers only bonds, debentures, notes, certificates or other evidence
of indebtedness, with interest coupons or in registered form, which are the instruments of
credit normally dealt with in the usual lending operations of a financial institution.Equity
holdings cannot come close to being, within the purview of "evidence of indebtedness" under
the second sentence of the aforequoted paragraph. Verily, it is for a like thesis that the loss
of petitioner bank in its equity in vestment in the Hongkong subsidiary cannot also be
deductible as a bad debt. The shares of stock in question do not constitute a loan extended by it
to its subsidiary (First CBC Capital) or a debt subject to obligatory repayment by the latter,
essential elements to constitute a bad debt, but a long term investment made by CBC.
One other item. Section 34(c)(1) of the NIRC , states that the entire amount of the gain or loss
upon the sale or exchange of property, as the case may be, shall be recognized. The complete
text reads:
SECTION 34. Determination of amount of and recognition of gain or loss.-
"(a) Computation of gain or loss. - The gain from the sale or other disposition of property shall
be the excess of the amount realized therefrom over the basis or adjusted basis for determining
gain and the loss shall be the excess of the basis or adjusted basis for determining loss over the
amount realized. The amount realized from the sale or other disposition of property shall be to
sum of money received plus the fair market value of the property (other than money)
received. (As amended by E.O. No. 37)
"(b) Basis for determining gain or loss from sale or disposition of property. - The basis of
property shall be - (1) The cost thereof in cases of property acquired on or before March 1,
1913, if such property was acquired by purchase; or
"(2) The fair market price or value as of the date of acquisition if the same was acquired by
inheritance; or
"(3) If the property was acquired by gift the basis shall be the same as if it would be in the
hands of the donor or the last preceding owner by whom it was not acquired by gift, except that
if such basis is greater than the fair market value of the property at the time of the gift, then for
the purpose of determining loss the basis shall be such fair market value; or
"(4) If the property, other than capital asset referred to in Section 21 (e), was acquired for less
than an adequate consideration in money or moneys worth, the basis of such property is (i) the
amount paid by the transferee for the property or (ii) the transferor's adjusted basis at the time of
the transfer whichever is greater.
"(5) The basis as defined in paragraph (c) (5) of this section if the property was acquired in a
transaction where gain or loss is not recognized under paragraph (c) (2) of this section. (As
amended by E.O. No. 37)
(c) Exchange of property.
"(1) General rule.- Except as herein provided, upon the sale or exchange of property, the entire
amount of the gain or loss, as the case may be, shall be recognized.
"(2) Exception. - No gain or loss shall be recognized if in pursuance of a plan of merger or
consolidation (a) a corporation which is a party to a merger or consolidation exchanges property
solely for stock in a corporation which is, a party to the merger or consolidation, (b) a
shareholder exchanges stock in a corporation which is a party to the merger or consolidation
solely for the stock in another corporation also a party to the merger or consolidation, or (c) a
security holder of a corporation which is a party to the merger or consolidation exchanges his
securities in such corporation solely for stock or securities in another corporation, a party to the
merger or consolidation.
"No gain or loss shall also be recognized if property is transferred to a corporation by a person
in exchange for stock in such corporation of which as a result of such exchange said person,
alone or together with others, not exceeding four persons, gains control of said
corporation: Provided, That stocks issued for services shall not be considered as issued in return
of property."
The above law should be taken within context on the general subject of the determination, and
recognition of gain or loss; it is not preclusive of, let alone renders completely inconsequential,
the more specific provisions of the code. Thus, pursuant, to the same section of the law, no such
recognition shall be made if the sale or exchange is made in pursuance of a plan of corporate
merger or consolidation or, if as a result of an exchange of property for stocks, the exchanger,
alone or together with others not exceeding four, gains control of the corporation. [7] Then, too,
how the resulting gain might be taxed, or whether or not the loss would be deductible and how,
are matters properly dealt with elsewhere in various other sections of the NIRC. [8] At all events,
it may not be amiss to once again stress that the basic rule is still that any capital loss can be
deducted only from capital gains under Section 33(c) of the NIRC.
In sum -
(a) The equity investment in shares of stock held by CBC of approximately 53% in its
Hongkong subsidiary, the First CBC Capital (Asia), Ltd., is not an indebtedness, and it is
a capital, not an ordinary, asset.[9]
(b) Assuming that the equity investment of CBC has indeed become "worthless," the
loss sustained is a capital, not an ordinary, loss.[10]
(c) The capital loss sustained by CBC can only be deducted from capital gains if any derived by
it during the same taxable year that the securities have become "worthless."[11]
WHEREFORE, the Petition is DENIED. The decision of the Court of Appeals disallowing the
claimed deduction of P16,227,851.80 is AFFIRMED.
SO ORDERED.
G.R. Nos. L-33665-68 February 27, 1987
COMMISSIONER OF INTERNAL REVENUE, petitioner,
vs.
VICENTE A. RUFINO and REMEDIOS S. RUFINO, ERNESTO D. RUFINO and
ELVIRA B. RUFINO, RAFAEL R. RUFINO and JULIETA A. RUFINO, MANUEL S.
GALVEZ and ESTER R. GALVEZ, and COURT OF TAX APPEALS, respondents.
Leonardo Abola for respondents.

CRUZ, J.:
Petition for review on certiorari of the decision of the Court of Tax Appeals absolving the
private respondents from liability for capital gains tax on the stocks received by them from the
Eastern Theatrical Inc. These were originally four cages involving appeals from the decision of
the Commissioner of Internal Revenue dated July 11, 1966, holding the said respondents,
Vicente A. Rufino and Remedies S. Rufino, Ernesto D. Rufino and Elvira B. Rufino, Rafael R.
Rufino and Julieta A. Rufino, and Manuel S. Galvez and Ester R. Galvez, liable for deficiency
income tax, surcharge and interest in the sums of P44,294.88, P27,229.44, P58,082.60 and
P58,074.24, respectively, for the year 1959.
The facts, as narrated by the Court of Tax Appeals, are as follows:
The private respondents were the majority stockholders of the defunct Eastern Theatrical Co.,
Inc., a corporation organized in 1934, for a period of twenty-five years terminating on January
25, 1959. It had an original capital stock of P500,000.00, which was increased in 1949 to
P2,000,000.00, divided into 200,000 shares at P10.00 per share, and was organized to engage in
the business of operating theaters, opera houses, places of amusement and other related business
enterprises, more particularly the Lyric and Capitol Theaters in Manila. The President of this
corporation (hereinafter referred to as the Old Corporation) during the year in question was
Ernesto D. Rufino.
The private respondents are also the majority and controlling stockholders of another
corporation, the Eastern Theatrical Co Inc., which was organized on December 8, 1958, for a
term of 50 years, with an authorized capital stock of P200,000.00, each share having a par value
of P10.00. This corporation is engaged in the same kind of business as the Old Corporation. The
General-Manager of this corporation (hereinafter referred to as the New Corporation) at the
time was Vicente A. Rufino.
In a special meeting of stockholders of the Old Corporation on December 17, 1958, to provide
for the continuation of its business after the end of its corporate life, and upon the
recommendation of its board of directors, a resolution was passed authorizing the Old
Corporation to merge with the New Corporation by transferring its business, assets, goodwill,
and liabilities to the latter, which in exchange would issue and distribute to the shareholders of
the Old Corporation one share for each share held by them in the said Corporation.
It was expressly declared that the merger of the Old Corporation with the New Corporation was
necessary to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even
after the expiration of the corporate existence of the former, in view of its pending booking
contracts, not to mention its collective bargaining agreements with its employees.
Pursuant to the said resolution, the Old Corporation, represented by Ernesto D. Rufino as
President, and the New Corporation, represented by Vicente A. Rufino as General Manager,
signed on January 9, 1959, a Deed of Assignment providing for the conveyance and transfer of
all the business, property, assets and goodwill of the Old Corporation to the New Corporation in
exchange for the latter's shares of stock to be distributed among the shareholders on the basis of
one stock for each stock held in the Old Corporation except that no new and unissued shares
would be issued to the shareholders of the Old Corporation; the delivery by the New
Corporation to the Old Corporation of 125,005-3/4 shares to be distributed to the shareholders
of the Old Corporation as their corresponding shares of stock in the New Corporation; the
assumption by the New Corporation of all obligations and liabilities of the Old Corporation
under its bargaining agreement with the Cinema Stage & Radio Entertainment Free Workers
(FFW) which included the retention of all personnel in the latter's employ; and the increase of
the capitalization of the New Corporation in compliance with their agreement. This agreement
was made retroactive to January 1, 1959.
The aforesaid transfer was eventually made by the Old Corporation to the New Corporation,
which continued the operation of the Lyric and Capitol Theaters and assumed all the obligations
and liabilities of the Old Corporation beginning January 1, 1959.
The resolution of the Old Corporation of December 17, 1958, and the Deed of Assignment of
January 9, 1959, were approved in a resolution by the stockholders of the New Corporation in
their special meeting on January 12, 1959. In the same meeting, the increased capitalization of
the New Corporation to P2,000,000.00 was also divided into 200,000 shares at P10.00 par value
each share, and the said increase was registered on March 5, 1959, with the Securities and
Exchange Commission, which approved the same on August 20,1959.
As agreed, and in exchange for the properties, and other assets of the Old Corporation, the New
Corporation issued to the stockholders of the former stocks in the New Corporation equal to the
stocks each one held in the Old Corporation, as follows:
Mr. & Mrs. Vicente A. Rufino............... 17,083 shares
Mr. & Mrs. Rafael R. Rufino ................. 16,881 shares
Mr. & Mrs. Ernesto D. Rufino .............. 18,347 shares
Mr. & Mrs. Manuel S. Galvez ............... 16,882 shares
It was this above-narrated series of transactions that the Bureau of Internal Revenue examined
later, resulting in the petitioner declaring that the merger of the aforesaid corporations was not
undertaken for a bona fide business purpose but merely to avoid liability for the capital gains
tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the
deficiency assessments against the private respondents for the amounts already mentioned. The
private respondents' request for reconsideration having been denied, they elevated the matter to
the Court of Tax Appeals, which reversed the petitioner.
We have given due course to the instant petition questioning the decision of the said court
holding that there was a valid merger between the Old Corporation and the New Corporation
and declaring that:
It is well established that where stocks for stocks were exchanged, and distributed to the
stockholders of the corporations, parties to the merger or consolidation, pursuant to a plan of
reorganization, such exchange is exempt from capital gains tax . . .
In view of the foregoing, we are of the opinion and so hold that no taxable gain was derived by
petitioners from the exchange of their old stocks solely for stocks of the New Corporation
pursuant to Section 35(c) (2), in relation to (c) (5), of the National Internal Revenue Code, as
amended by Republic Act 1921. 1
The above-cited Section 35 of the Tax Code, on the proper interpretation and application of
which the resolution of this case depends, provides in material part as follows:
Sec. 35. Determination of gain or loss from the sale or other disposition of property. The
gain derived or loss sustained from the sale or other disposition of property, real, personal or
mixed, shall be determined in accordance with the following schedule:
xxx xxx xxx
(c) Exchange of property-
(1) General Rule. Except as herein provided upon the sale or exchange of property, the entire
amount of the gain or loss, as the case may be, shall be recognized.
(2) Exceptions. No gain or loss shall be recognized if in pursuance of a plan of merger or
consolidation (a) a corporation which is a party to a merger or consolidation, exchanges
property solely for stock in a corporation which is a party to the merger or consolidation, (b) a
shareholder exchanges stock in a corporation which is a party to the merger or consolidation
solely for the stock of another corporation, also a party to the merger or consolidation, or (c) a
security holder of a corporation which is a party to the merger or consolidation exchanges his
securities in such corporation solely for stock or securities in another corporation, a party to the
merger or consolidation.
xxx xxx xxx
(5) Definitions.-(a) x x x (b) The term "merger" or "consolidation," when used in this section,
shall be understood to mean: (1) The ordinary merger or consolidation, or (2) the acquisition by
one corporation of all or substantially all the properties of another corporation solely for stock;
Provided, That for a transaction to be regarded as a merger or consolidation within the purview
of this section, it must be undertaken for a bona fidebusiness purpose and not solely for the
purpose of escaping the burden of taxation; Provided further, That in determining whether a
bona fide business purpose exists, each and every step of the transaction shall be considered and
the whole transaction or series of transactions shall be treated as a single unit: ...
In support of its position that the Deed of Assignment was concluded by the private respondents
merely to evade the burden of taxation, the petitioner points to the fact that the New
Corporation did not actually issue stocks in exchange for the properties of the Old Corporation
at the time of the supposed merger on January 9, 1959. The exchange, he says, was only on
paper. The increase in capitalization of the New Corporation was registered with the Securities
and Exchange Commission only on March 5, 1959, or 37 days after the Old Corporation
expired on January 25, 1959. Prior to such registration, it was not possible for the New
Corporation to effect the exchange provided for in the said agreement because it was capitalized
only at P200,000.00 as against the capitalization of the Old Corporation at P2,000,000.00.
Consequently, as there was no merger, the automatic dissolution of the Old Corporation on its
expiry date resulted in its liquidation, for which the respondents are now liable in taxes on their
capital gains.
For their part, the private respondents insist that there was a genuine merger between the Old
Corporation and the New Corporation pursuant to a plan aimed at enabling the latter to continue
the business of the former in the operation of places of amusement, specifically the Capitol and
Lyric Theaters. The plan was evolved through the series of transactions above narrated, all of
which could be treated as a single unit in accordance with the requirements of Section 35.
Obviously, all these steps did not have to be completed at the time of the merger, as there were
some of them, such as the increase and distribution of the stock of the New Corporation, which
necessarily had to come afterwards. Moreover, the Old Corporation was dissolved on January 1,
1959, pursuant to the Deed of Assignment, and not on January 25, 1959, its original expiry date.
As the properties of the Old Corporation were transferred to the New Corporation before that
expiry date, there could not have been any distribution of liquidating dividends by the Old
Corporation for which the private respondents should be held liable in taxes.
We sustain the Court of Tax Appeals. We hold that it did not err in finding that no taxable gain
was derived by the private respondents from the questioned transaction.
Contrary to the claim of the petitioner, there was a valid merger although the actual transfer of
the properties subject of the Deed of Assignment was not made on the date of the merger. In the
nature of things, this was not possible. Obviously, it was necessary for the Old Corporation to
surrender its net assets first to the New Corporation before the latter could issue its own stock to
the shareholders of the Old Corporation because the New Corporation had to increase its
capitalization for this purpose. This required the adoption of the resolution to this effect at the
special stockholders meeting of the New Corporation on January 12, 1959, the registration of
such issuance with the SEC on March 5, 1959, and its approval by that body on August 20,
1959. All these took place after the date of the merger but they were deemed part and parcel of,
and indispensable to the validity and enforceability of, the Deed of Assignment.
The Court finds no impediment to the exchange of property for stock between the two
corporations being considered to have been effected on the date of the merger. That, in fact, was
the intention, and the reason why the Deed of Assignment was made retroactive to January 1,
1959. Such retroaction provided in effect that all transactions set forth in the merger agreement
shall be deemed to be taking place simultaneously on January 1, 1959, when the Deed of
Assignment became operative.
The certificates of stock subsequently delivered by the New Corporation to the private
respondents were only evidence of the ownership of such stocks. Although these certificates
could be issued to them only after the approval by the SEC of the increase in capitalization of
the New Corporation, the title thereto, legally speaking, was transferred to them on the date the
merger took effect, in accordance with the Deed of Assignment.
The basic consideration, of course, is the purpose of the merger, as this would determine
whether the exchange of properties involved therein shall be subject or not to the capital gains
tax. The criterion laid down by the law is that the merger" must be undertaken for a bona
fide business purpose and not solely for the purpose of escaping the burden of taxation." We
must therefore seek and ascertain the intention of the parties in the light of their conduct
contemporaneously with, and especially after, the questioned merger pursuant to the Deed of
Assignment of January 9, 1959.
It has been suggested that one certain indication of a scheme to evade the capital gains tax is the
subsequent dissolution of the new corporation after the transfer to it of the properties of the old
corporation and the liquidation of the former soon thereafter. This highly suspect development
is likely to be a mere subterfuge aimed at circumventing the requirements of Section 35 of the
Tax Code while seeming to be a valid corporate combination. Speaking of such a device, Justice
Sutherland declared for the United States Supreme Court in Helvering v. Gregory:
When subdivision (b) speaks of a transfer of assets by one corporation to another, it means a
transfer made 'in pursuance of a plan of reorganization' (Section 112[g]) of corporate business;
and not a transfer of assets by one corporation to another in pursuance of a plan having no
relation to the business of either, as plainly is the case here. Putting aside, then, the question of
motive in respect of taxation altogether, and fixing the character of proceeding by what actually
occurred, what do we find? Simply an operation having no business or corporate purpose a
mere devise which put on the form of a corporate reorganization as a disguise for concealing its
real character, and the sole object and accomplishment of which was the consummation of a
preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel
of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But
that corporation was nothing more than a contrivance to the end last described. It was brought
into existence for no other purpose; it performed, as it was intended from the beginning it
should perform, no other function. When that limited function had been exercised, it
immediately was put to death.
In these circumstances, the facts speak for themselves and are susceptible of but one
interpretation. The whole undertaking, though conducted according to the terms of subdivision
(b), was in fact an elaborate and devious form of conveyance masquerading as a corporate
reorganization and nothing else. The rule which excludes from consideration the motive of tax
avoidance is not pertinent to the situation, because the transaction upon its face lies outside the
plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to
deprive the statutory provision in question of all serious purpose. 2
We see no such furtive intention in the instant case. It is clear, in fact, that the purpose of the
merger was to continue the business of the Old Corporation, whose corporate life was about to
expire, through the New Corporation to which all the assets and obligations of the former had
been transferred. What argues strongly, indeed, for the New Corporation is that it was not
dissolved after the merger agreement in 1959. On the contrary, it continued to operate the places
of amusement originally owned by the Old Corporation and transfered to the New Corporation,
particularly the Capitol and Lyric Theaters, in accordance with the Deed of Assignment. The
New Corporation, in fact, continues to do so today after taking over the business of the Old
Corporation twenty-seven years ago.
It may be recalled at this point that under the original provisions of the old Corporation Law,
which was in effect when the merger agreement was concluded in 1959, it was not possible for
a corporation, by mere amendment of its charter, to extend its life beyond the time fixed in the
original articles; in fact, this was specifically prohibited by Section 18, which provided that
"any corporation may amend its articles of incorporation by a majority vote of its board of
directors or trustees and the vote or written assent of two-thirds of its members, if it be a non-
stock corporation, or if it be a stock corporation, by the vote or written assent of the
stockholders representing at least two-thirds of the subscribed capital stock of the corporation ...
: Provided, however, That the life of said corporation shall not be extended by said amendment
beyond the fixed in the original articles ... "
This prohibition, which incidentally has since been deleted, made it necessary for the Old and
New Corporations to enter into the questioned merger, to enable the former to continue its
unfinished business through the latter.
The procedure for such merger was prescribed in Section 28 1/2 of the old Corporation Law
which, although not expressly authorizing a merger by name (as the new Corporation Code now
does in its Section 77), provided that "a corporation may, by action taken at any meeting of its
board of directors, sell, lease, exchange, or otherwise dispose of all or substantially all of its
property and assets, including its goodwill, upon such terms and conditions and for such
considerations, which may be money, stocks, bond, or other instruments for the payment of
money or other property or other considerations, as its board of directors deem expedient." The
transaction contemplated in the old law covered the second type of merger defined by Section
35 of the Tax Code as "the acquisition by one corporation of all or substantially all of the
properties of another corporation solely for stock," which is precisely what happened in the
present case.
What is also worth noting is that, as in the case of the Old Corporation when it was dissolved on
December 31, 1958, there has been no distribution of the assets of the New Corporation since
then and up to now, as far as the record discloses. To date, the private respondents have not
derived any benefit from the merger of the Old Corporation and the New Corporation almost
three decades earlier that will make them subject to the capital gains tax under Section 35. They
are no more liable now than they were when the merger took effect in 1959, as the merger,
being genuine, exempted them under the law from such tax.
By this decision, the government is, of course, not left entirely without recourse, at least in the
future. The fact is that the merger had merely deferred the claim for taxes, which may be
asserted by the government later, when gains are realized and benefits are distributed among the
stockholders as a result of the merger. In other words, the corresponding taxes are not forever
foreclosed or forfeited but may at the proper time and without prejudice to the government still
be imposed upon the private respondents, in accordance with Section 35(c) (4) of the Tax Code.
Then, in assessing the tax, "the basis of the property transferred in the hands of the transferee
shall be the same as it would be in the hands of the transferor, increased by the amount of gain
recognized to the transferor on the transfer." The only inhibition now is that time has not yet
come.
The reason for this conclusion is traceable to the purpose of the legislature in adopting the
provision of law in question. The basic Idea was to correct the Tax Code which, by imposing
taxes on corporate combinations and expansions, discouraged the same to the detriment of
economic progress, particularly the promotion of local industry. Speaking of this problem, HB
No. 7233, which was subsequently enacted into R.A. No. 1921 embodying Section 35 as now
worded, declared in the Explanatory Note:
The exemption from the tax of the gain derived from exchanges of stock solely for stock of
another corporation resulting from corporate mergers or consolidations under the above
provisions, as amended, was intended to encourage corporations in pooling, combining or
expanding their resources conducive to the economic development of the country. 3
Our ruling then is that the merger in question involved a pooling of resources aimed at the
continuation and expansion of business and so came under the letter and intendment of the
National Internal Revenue Code, as amended by the abovecited law, exempting from the capital
gains tax exchanges of property effected under lawful corporate combinations.
WHEREFORE, the decision of the Court of Tax Appeals is affirmed in full, without any
pronouncement as to costs.
SO ORDERED.
EN BANC

COMMISSIONER OF G. R. No. 163653

INTERNAL REVENUE,
Petitioner,
G. R. No. 167689
-versus-
FILINVEST DEVELOPMENT
Promulgated:
CORPORATION,
Respondent.
July 19, 2011
x-------------------------------------x
COMMISSIONER OF
INTERNAL REVENUE,
Petitioner,
-versus-
FILINVEST DEVELOPMENT
CORPORATION,
Respondent.
x----------------------------------------------------------------------------------------------- x
DECISION
PEREZ, J.:

Assailed in these twin petitions for review on certiorari filed pursuant to Rule 45 of the 1997
Rules of Civil Procedure are the decisions rendered by the Court of Appeals (CA) in the
following cases: (a) Decision dated 16 December 2003 of the then Special Fifth Division in
CA-G.R. SP No. 72992;[1] and, (b) Decision dated 26 January 2005 of the then Fourteenth
Division in CA-G.R. SP No. 74510.[2]

The Facts
The owner of 80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI),
respondent Filinvest Development Corporation (FDC) is a holding company which also owned
67.42% of the outstanding shares of Filinvest Land, Inc. (FLI). On 29 November 1996, FDC
and FAI entered into a Deed of Exchange with FLI whereby the former both transferred in favor
of the latter parcels of land appraised at P4,306,777,000.00. In exchange for said parcels which
were intended to facilitate development of medium-rise residential and commercial buildings,
463,094,301 shares of stock of FLI were issued to FDC and FAI. [3] As a result of the exchange,
FLIs ownership structure was changed to the extent reflected in the following tabular prcis, viz.:

Stockhold Number and Number of Number and

er Percentage of Additional Percentage of
Shares Held Prior to Shares Shares Held After
the Exchange Issued the Exchange

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

% %

FAI 00 420,877,00 420,877,000 9.96%

0

OTHERS 1,226,177,000 32.58 0 1,226,177,000 29.01

% %

----------------- ------- ------------- ---------------

---- -

3,763,535,000 100% 463,094,30 4,226,629,000 (100

1 %)

On 13 January 1997, FLI requested a ruling from the Bureau of Internal Revenue (BIR) to the
effect that no gain or loss should be recognized in the aforesaid transfer of real
properties. Acting on the request, the BIR issued Ruling No. S-34-046-97 dated 3 February
1997, finding that the exchange is among those contemplated under Section 34 (c) (2) of the old
National Internal Revenue Code (NIRC)[4] which provides that (n)o gain or loss shall be
recognized if property is transferred to a corporation by a person in exchange for a stock in such
corporation of which as a result of such exchange said person, alone or together with others, not
exceeding four (4) persons, gains control of said corporation."[5] With the BIRs reiteration of the
foregoing ruling upon the 10 February 1997 request for clarification filed by FLI, [6] the latter,
together with FDC and FAI, complied with all the requirements imposed in the ruling.[7]

On various dates during the years 1996 and 1997, in the meantime, FDC also extended
advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central Corporation (DSCC)
and Filinvest Capital, Inc. (FCI).[8] Duly evidenced by instructional letters as well as cash and
journal vouchers, said cash advances amounted to P2,557,213,942.60 in
[9] [10]
1996 and P3,360,889,677.48 in 1997. On 15 November 1996, FDC also entered into a
Shareholders Agreement with Reco Herrera PTE Ltd. (RHPL) for the formation of a Singapore-
based joint venture company called Filinvest Asia Corporation (FAC), tasked to develop and
manage FDCs 50% ownership of its PBCom Office Tower Project (the Project). With their
equity participation in FAC respectively pegged at 60% and 40% in the Shareholders
Agreement, FDC subscribed to P500.7 million worth of shares in said joint venture company to
RHPLs subscription worth P433.8 million. Having paid its subscription by executing a Deed of
Assignment transferring to FAC a portion of its rights and interest in the Project worth P500.7
million, FDC eventually reported a net loss of P190,695,061.00 in its Annual Income Tax
Return for the taxable year 1996.[11]

On 3 January 2000, FDC received from the BIR a Formal Notice of Demand to pay deficiency
income and documentary stamp taxes, plus interests and compromise penalties, [12] covered by
the following Assessment Notices, viz.: (a) Assessment Notice No. SP-INC-96-00018-2000 for
deficiency income taxes in the sum of P150,074,066.27 for 1996; (b) Assessment Notice No.
SP-DST-96-00020-2000 for deficiency documentary stamp taxes in the sum of P10,425,487.06
for 1996; (c) Assessment Notice No. SP-INC-97-00019-2000 for deficiency income taxes in the
sum of P5,716,927.03 for 1997; and (d) Assessment Notice No. SP-DST-97-00021-2000 for
deficiency documentary stamp taxes in the sum of P5,796,699.40 for 1997.[13] The foregoing
deficiency taxes were assessed on the taxable gain supposedly realized by FDC from the Deed
of Exchange it executed with FAI and FLI, on the dilution resulting from the Shareholders
Agreement FDC executed with RHPL as well as the arms-length interest rate and documentary
stamp taxes imposable on the advances FDC extended to its affiliates.[14]

On 3 January 2000, FAI similarly received from the BIR a Formal Letter of Demand for
deficiency income taxes in the sum of P1,477,494,638.23 for the year 1997.[15] Covered by
Assessment Notice No. SP-INC-97-0027-2000,[16] said deficiency tax was also assessed on the
taxable gain purportedly realized by FAI from the Deed of Exchange it executed with FDC and
FLI.[17] On 26 January 2000 or within the reglementary period of thirty (30) days from notice of
the assessment, both FDC and FAI filed their respective requests for reconsideration/protest, on
the ground that the deficiency income and documentary stamp taxes assessed by the BIR were
bereft of factual and legal basis.[18]Having submitted the relevant supporting documents
pursuant to the 31 January 2000 directive from the BIR Appellate Division, FDC and FAI filed
on 11 September 2000 a letter requesting an early resolution of their request for
reconsideration/protest on the ground that the 180 days prescribed for the resolution thereof
under Section 228 of the NIRC was going to expire on 20 September 2000.[19]

In view of the failure of petitioner Commissioner of Internal Revenue (CIR) to resolve their
request for reconsideration/protest within the aforesaid period, FDC and FAI filed on 17
October 2000 a petition for review with the Court of Tax Appeals (CTA) pursuant to Section
228 of the 1997 NIRC. Docketed before said court as CTA Case No. 6182, the petition alleged,
among other matters, that as previously opined in BIR Ruling No. S-34-046-97, no taxable gain
should have been assessed from the subject Deed of Exchange since FDC and FAI collectively
gained further control of FLI as a consequence of the exchange; that correlative to the CIR's
lack of authority to impute theoretical interests on the cash advances FDC extended in favor of
its affiliates, the rule is settled that interests cannot be demanded in the absence of a stipulation
to the effect; that not being promissory notes or certificates of obligations, the instructional
letters as well as the cash and journal vouchers evidencing said cash advances were not subject
to documentary stamp taxes; and, that no income tax may be imposed on the prospective gain
from the supposed appreciation of FDC's shareholdings in FAC. As a consequence, FDC and
FAC both prayed that the subject assessments for deficiency income and documentary stamp
taxes for the years 1996 and 1997 be cancelled and annulled.[20]

On 4 December 2000, the CIR filed its answer, claiming that the transfer of property in question
should not be considered tax free since, with the resultant diminution of its shares in FLI, FDC
did not gain further control of said corporation. Likewise calling attention to the fact that the
cash advances FDC extended to its affiliates were interest free despite the interest bearing loans
it obtained from banking institutions, the CIR invoked Section 43 of the old NIRC which, as
implemented by Revenue Regulations No. 2, Section 179 (b) and (c), gave him "the power to
allocate, distribute or apportion income or deductions between or among such organizations,
trades or business in order to prevent evasion of taxes." The CIR justified the imposition of
documentary stamp taxes on the instructional letters as well as cash and journal vouchers for
said cash advances on the strength of Section 180 of the NIRC and Revenue Regulations No. 9-
94 which provide that loan transactions are subject to said tax irrespective of whether or not
they are evidenced by a formal agreement or by mere office memo. The CIR also argued that
FDC realized taxable gain arising from the dilution of its shares in FAC as a result of its
Shareholders' Agreement with RHPL.[21]

At the pre-trial conference, the parties filed a Stipulation of Facts, Documents and
Issues[22] which was admitted in the 16 February 2001 resolution issued by the CTA. With the
further admission of the Formal Offer of Documentary Evidence subsequently filed by FDC and
FAI[23] and the conclusion of the testimony of Susana Macabelda anent the cash advances FDC
extended in favor of its affiliates,[24] the CTA went on to render the Decision dated 10 September
2002 which, with the exception of the deficiency income tax on the interest income FDC
supposedly realized from the advances it extended in favor of its affiliates, cancelled the rest of
deficiency income and documentary stamp taxes assessed against FDC and FAI for the years
1996 and 1997,[25] thus:

WHEREFORE, in view of all the foregoing, the court finds the instant petition partly
meritorious. Accordingly, Assessment Notice No. SP-INC-96-00018-2000 imposing deficiency
income tax on FDC for taxable year 1996, Assessment Notice No. SP-DST-96-00020-2000 and
SP-DST-97-00021-2000 imposing deficiency documentary stamp tax on FDC for taxable years
1996 and 1997, respectively and Assessment Notice No. SP-INC-97-0027-2000 imposing
deficiency income tax on FAI for the taxable year 1997 are hereby CANCELLED and SET
ASIDE.However, [FDC] is hereby ORDERED to PAY the amount of P5,691,972.03 as
deficiency income tax for taxable year 1997. In addition, petitioner is also ORDERED to
PAY 20% delinquency interest computed from February 16, 2000 until full payment thereof
pursuant to Section 249 (c) (3) of the Tax Code.[26]

Finding that the collective increase of the equity participation of FDC and FAI in FLI rendered
the gain derived from the exchange tax-free, the CTA also ruled that the increase in the value of
FDC's shares in FAC did not result in economic advantage in the absence of actual sale or
conversion thereof. While likewise finding that the documents evidencing the cash advances
FDC extended to its affiliates cannot be considered as loan agreements that are subject to
documentary stamp tax, the CTA enunciated, however, that the CIR was justified in assessing
undeclared interests on the same cash advances pursuant to his authority under Section 43 of the
NIRC in order to forestall tax evasion. For persuasive effect, the CTA referred to the equivalent
provision in the Internal Revenue Code of the United States (IRC-US), i.e., Sec. 482, as
implemented by Section 1.482-2 of 1965-1969 Regulations of the Law of Federal Income
Taxation.[27]

Dissatisfied with the foregoing decision, FDC filed on 5 November 2002 the petition for review
docketed before the CA as CA-G.R. No. 72992, pursuant to Rule 43 of the 1997 Rules of Civil
Procedure. Calling attention to the fact that the cash advances it extended to its affiliates were
interest-free in the absence of the express stipulation on interest required under Article 1956 of
the Civil Code, FDC questioned the imposition of an arm's-length interest rate thereon on the
ground, among others, that the CIR's authority under Section 43 of the NIRC: (a) does not
include the power to impute imaginary interest on said transactions; (b) is directed only against
controlled taxpayers and not against mother or holding corporations; and, (c) can only be
invoked in cases of understatement of taxable net income or evident tax evasion. [28] Upholding
FDC's position, the CA's then Special Fifth Division rendered the herein assailed decision dated
16 December 2003,[29] the decretal portion of which states:

WHEREFORE, premises considered, the instant petition is hereby GRANTED. The assailed
Decision dated September 10, 2002 rendered by the Court of Tax Appeals in CTA Case No.
6182 directing petitioner Filinvest Development Corporation to pay the amount
of P5,691,972.03 representing deficiency income tax on allegedly undeclared interest income
for the taxable year 1997, plus 20% delinquency interest computed from February 16, 2000
until full payment thereof is REVERSED and SET ASIDE and, a new one entered annulling
Assessment Notice No. SP-INC-97-00019-2000 imposing deficiency income tax on petitioner
for taxable year 1997. No pronouncement as to costs.[30]

With the denial of its partial motion for reconsideration of the same 11 December 2002
resolution issued by the CTA,[31] the CIR also filed the petition for review docketed before the
CA as CA-G.R. No. 74510. In essence, the CIR argued that the CTA reversibly erred in
cancelling the assessment notices: (a) for deficiency income taxes on the exchange of property
between FDC, FAI and FLI; (b) for deficiency documentary stamp taxes on the documents
evidencing FDC's cash advances to its affiliates; and (c) for deficiency income tax on the gain
FDC purportedly realized from the increase of the value of its shareholdings in FAC. [32] The
foregoing petition was, however, denied due course and dismissed for lack of merit in the herein
assailed decision dated 26 January 2005[33] rendered by the CA's then Fourteenth Division, upon
the following findings and conclusions, to wit:
1. As affirmed in the 3 February 1997 BIR Ruling No. S-34-046-97, the 29 November 1996
Deed of Exchange resulted in the combined control by FDC and FAI of more than 51% of the
outstanding shares of FLI, hence, no taxable gain can be recognized from the transaction under
Section 34 (c) (2) of the old NIRC;
2. The instructional letters as well as the cash and journal vouchers evidencing the advances
FDC extended to its affiliates are not subject to documentary stamp taxes pursuant to BIR
Ruling No. 116-98, dated 30 July 1998, since they do not partake the nature of loan agreements;

3. Although BIR Ruling No. 116-98 had been subsequently modified by BIR Ruling No. 108-
99, dated 15 July 1999, to the effect that documentary stamp taxes are imposable on inter-office
memos evidencing cash advances similar to those extended by FDC, said latter ruling cannot be
given retroactive application if to do so would be prejudicial to the taxpayer;

4. FDC's alleged gain from the increase of its shareholdings in FAC as a consequence of the
Shareholders' Agreement it executed with RHPL cannot be considered taxable income since,
until actually converted thru sale or disposition of said shares, they merely represent unrealized
increase in capital.[34]

Respectively docketed before this Court as G.R. Nos. 163653 and 167689, the CIR's petitions
for review on certiorari assailing the 16 December 2003 decision in CA-G.R. No. 72992 and
the 26 January 2005 decision in CA-G.R. SP No. 74510 were consolidated pursuant to the 1
March 2006 resolution issued by this Courts Third Division.

The Issues

In G.R. No. 163653, the CIR urges the grant of its petition on the following ground:

THE COURT OF APPEALS ERRED IN REVERSING THE DECISION OF THE

COURT OF TAX APPEALS AND IN HOLDING THAT THE ADVANCES EXTENDED
BY RESPONDENT TO ITS AFFILIATES ARE NOT SUBJECT TO INCOME TAX.[35]
In G.R. No. 167689, on the other hand, petitioner proffers the following issues for resolution:

THE HONORABLE COURT OF APPEALS COMMITTED GRAVE ABUSE OF

DISCRETION IN HOLDING THAT THE EXCHANGE OF SHARES OF STOCK FOR
PROPERTY AMONG FILINVEST DEVELOPMENT CORPORATION (FDC),
FILINVEST ALABANG, INCORPORATED (FAI) AND FILINVEST LAND
INCORPORATED (FLI) MET ALL THE REQUIREMENTS FOR THE NON-
RECOGNITION OF TAXABLE GAIN UNDER SECTION 34 (c) (2) OF THE OLD
NATIONAL INTERNAL REVENUE CODE (NIRC) (NOW SECTION 40 (C) (2) (c) OF
THE NIRC.

II

THE HONORABLE COURT OF APPEALS COMMITTED REVERSIBLE ERROR IN

HOLDING THAT THE LETTERS OF INSTRUCTION OR CASH VOUCHERS
EXTENDED BY FDC TO ITS AFFILIATES ARE NOT DEEMED LOAN
AGREEMENTS SUBJECT TO DOCUMENTARY STAMP TAXES UNDER SECTION
180 OF THE NIRC.

III

THE HONORABLE COURT OF APPEALS GRAVELY ERRED IN HOLDING THAT

GAIN ON DILUTION AS A RESULT OF THE INCREASE IN THE VALUE OF FDCS
SHAREHOLDINGS IN FAC IS NOT TAXABLE.[36]

The Courts Ruling

While the petition in G.R. No. 163653 is bereft of merit, we find the CIRs petition in G.R. No.
167689 impressed with partial merit.
In G.R. No. 163653, the CIR argues that the CA erred in reversing the CTAs finding that
theoretical interests can be imputed on the advances FDC extended to its affiliates in 1996 and
1997 considering that, for said purpose, FDC resorted to interest-bearing fund borrowings from
commercial banks. Since considerable interest expenses were deducted by FDC when said
funds were borrowed, the CIR theorizes that interest income should likewise be declared when
the same funds were sourced for the advances FDC extended to its affiliates. Invoking Section
43 of the 1993 NIRC in relation to Section 179(b) of Revenue Regulation No. 2, the CIR
maintains that it is vested with the power to allocate, distribute or apportion income or
deductions between or among controlled organizations, trades or businesses even in the absence
of fraud, since said power is intended to prevent evasion of taxes or clearly to reflect the income
of any such organizations, trades or businesses. In addition, the CIR asseverates that the CA
should have accorded weight and respect to the findings of the CTA which, as the specialized
court dedicated to the study and consideration of tax matters, can take judicial notice of US
income tax laws and regulations.[37]

Admittedly, Section 43 of the 1993 NIRC[38] provides that, (i)n any case of two or more
organizations, trades or businesses (whether or not incorporated and whether or not organized in
the Philippines) owned or controlled directly or indirectly by the same interests, the
Commissioner of Internal Revenue is authorized to distribute, apportion or allocate gross
income or deductions between or among such organization, trade or business, if he determines
that such distribution, apportionment or allocation is necessary in order to prevent evasion of
taxes or clearly to reflect the income of any such organization, trade or business. In
amplification of the equivalent provision[39] under Commonwealth Act No. 466,[40] Sec. 179(b)
of Revenue Regulation No. 2 states as follows:

Determination of the taxable net income of controlled taxpayer. (A) DEFINITIONS. When used
in this section
(1) The term organization includes any kind, whether it be a sole proprietorship, a
partnership, a trust, an estate, or a corporation or association, irrespective of the place where
organized, where operated, or where its trade or business is conducted, and regardless of
whether domestic or foreign, whether exempt or taxable, or whether affiliated or not.
(2) The terms trade or business include any trade or business activity of any kind,
regardless of whether or where organized, whether owned individually or otherwise, and
regardless of the place where carried on.
(3) The term controlled includes any kind of control, direct or indirect, whether legally
enforceable, and however exercisable or exercised. It is the reality of the control which is
decisive, not its form or mode of exercise. A presumption of control arises if income or
deductions have been arbitrarily shifted.
(4) The term controlled taxpayer means any one of two or more organizations, trades,
or businesses owned or controlled directly or indirectly by the same interests.
(5) The term group and group of controlled taxpayers means the organizations, trades
or businesses owned or controlled by the same interests.
(6) The term true net income means, in the case of a controlled taxpayer, the net
income (or as the case may be, any item or element affecting net income) which would have
resulted to the controlled taxpayer, had it in the conduct of its affairs (or, as the case may be,
any item or element affecting net income) which would have resulted to the controlled taxpayer,
had it in the conduct of its affairs (or, as the case may be, in the particular contract, transaction,
arrangement or other act) dealt with the other members or members of the group at arms
length. It does not mean the income, the deductions, or the item or element of either, resulting to
the controlled taxpayer by reason of the particular contract, transaction, or arrangement, the
controlled taxpayer, or the interest controlling it, chose to make (even though such contract,
transaction, or arrangement be legally binding upon the parties thereto).

(B) SCOPE AND PURPOSE. - The purpose of Section 44 of the Tax Code is to place a
controlled taxpayer on a tax parity with an uncontrolled taxpayer, by determining, according to
the standard of an uncontrolled taxpayer, the true net income from the property and business of
a controlled taxpayer. The interests controlling a group of controlled taxpayer are assumed to
have complete power to cause each controlled taxpayer so to conduct its affairs that its
transactions and accounting records truly reflect the net income from the property and business
of each of the controlled taxpayers. If, however, this has not been done and the taxable net
income are thereby understated, the statute contemplates that the Commissioner of Internal
Revenue shall intervene, and, by making such distributions, apportionments, or allocations as he
may deem necessary of gross income or deductions, or of any item or element affecting net
income, between or among the controlled taxpayers constituting the group, shall determine the
true net income of each controlled taxpayer. The standard to be applied in every case is that of
an uncontrolled taxpayer. Section 44 grants no right to a controlled taxpayer to apply its
provisions at will, nor does it grant any right to compel the Commissioner of Internal Revenue
to apply its provisions.
(C) APPLICATION Transactions between controlled taxpayer and another will be subjected to
special scrutiny to ascertain whether the common control is being used to reduce, avoid or
escape taxes. In determining the true net income of a controlled taxpayer, the Commissioner of
Internal Revenue is not restricted to the case of improper accounting, to the case of a fraudulent,
colorable, or sham transaction, or to the case of a device designed to reduce or avoid tax by
shifting or distorting income or deductions. The authority to determine true net income extends
to any case in which either by inadvertence or design the taxable net income in whole or in part,
of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his
affairs been an uncontrolled taxpayer dealing at arms length with another uncontrolled taxpayer.
[41]

As may be gleaned from the definitions of the terms controlled and "controlled taxpayer" under
paragraphs (a) (3) and (4) of the foregoing provision, it would appear that FDC and its affiliates
come within the purview of Section 43 of the 1993 NIRC. Aside from owning significant
portions of the shares of stock of FLI, FAI, DSCC and FCI, the fact that FDC extended
substantial sums of money as cash advances to its said affiliates for the purpose of providing
them financial assistance for their operational and capital expenditures seemingly indicate that
the situation sought to be addressed by the subject provision exists. From the tenor of paragraph
(c) of Section 179 of Revenue Regulation No. 2, it may also be seen that the CIR's power to
distribute, apportion or allocate gross income or deductions between or among controlled
taxpayers may be likewise exercised whether or not fraud inheres in the transaction/s under
scrutiny. For as long as the controlled taxpayer's taxable income is not reflective of that which it
would have realized had it been dealing at arm's length with an uncontrolled taxpayer, the CIR
can make the necessary rectifications in order to prevent evasion of taxes.

Despite the broad parameters provided, however, we find that the CIR's powers of distribution,
apportionment or allocation of gross income and deductions under Section 43 of the 1993 NIRC
and Section 179 of Revenue Regulation No. 2 does not include the power to impute "theoretical
interests" to the controlled taxpayer's transactions. Pursuant to Section 28 of the 1993 NIRC,
[42]
after all, the term gross income is understood to mean all income from whatever
source derived, including, but not limited to the following items: compensation for services,
including fees, commissions, and similar items; gross income derived from business; gains
derived from dealings in property; interest; rents; royalties; dividends; annuities; prizes and
winnings; pensions; and partners distributive share of the gross income of general professional
partnership.[43] While it has been held that the phrase "from whatever source derived" indicates a
legislative policy to include all income not expressly exempted within the class of taxable
income under our laws, the term "income" has been variously interpreted to mean
"cash received or its equivalent", "the amount of money coming to a person within a specific
time" or "something distinct from principal or capital." [44] Otherwise stated, there must be proof
of the actual or, at the very least, probable receipt or realization by the controlled taxpayer of
the item of gross income sought to be distributed, apportioned or allocated by the CIR.

Our circumspect perusal of the record yielded no evidence of actual or possible showing that
the advances FDC extended to its affiliates had resulted to the interests subsequently assessed
by the CIR. For all its harping upon the supposed fact that FDC had resorted to borrowings
from commercial banks, the CIR had adduced no concrete proof that said funds were, indeed,
the source of the advances the former provided its affiliates. While admitting that FDC obtained
interest-bearing loans from commercial banks,[45] Susan Macabelda - FDC's Funds Management
Department Manager who was the sole witness presented before the CTA - clarified that the
subject advances were sourced from the corporation's rights offering in 1995 as well as the sale
of its investment in Bonifacio Land in 1997.[46] More significantly, said witness testified that
said advances: (a) were extended to give FLI, FAI, DSCC and FCI financial assistance for their
operational and capital expenditures; and, (b) were all temporarily in nature since they were
repaid within the duration of one week to three months and were evidenced by mere journal
entries, cash vouchers and instructional letters.[47]

Even if we were, therefore, to accord precipitate credulity to the CIR's bare assertion that FDC
had deducted substantial interest expense from its gross income, there would still be no factual
basis for the imputation of theoretical interests on the subject advances and assess deficiency
income taxes thereon. More so, when it is borne in mind that, pursuant to Article 1956 of
the Civil Code of the Philippines, no interest shall be due unless it has been expressly stipulated
in writing. Considering that taxes, being burdens, are not to be presumed beyond what the
applicable statute expressly and clearly declares,[48] the rule is likewise settled that tax statutes
must be construed strictly against the government and liberally in favor of the taxpayer.
[49]
Accordingly, the general rule of requiring adherence to the letter in construing statutes
applies with peculiar strictness to tax laws and the provisions of a taxing act are not to be
extended by implication.[50] While it is true that taxes are the lifeblood of the government, it has
been held that their assessment and collection should be in accordance with law as any
arbitrariness will negate the very reason for government itself.[51]

In G.R. No. 167689, we also find a dearth of merit in the CIR's insistence on the imposition of
deficiency income taxes on the transfer FDC and FAI effected in exchange for the shares of
stock of FLI. With respect to the Deed of Exchange executed between FDC, FAI and FLI,
Section 34 (c) (2) of the 1993 NIRC pertinently provides as follows:
Sec. 34. Determination of amount of and recognition of gain or loss.-
xxxx

(c) Exception x x x x

No gain or loss shall also be recognized if property is transferred to a corporation by a person

in exchange for shares of stock in such corporation of which as a result of such exchange said
person, alone or together with others, not exceeding four persons, gains control of said
corporation; Provided, That stocks issued for services shall not be considered as issued in
return of property.
As even admitted in the 14 February 2001 Stipulation of Facts submitted by the parties, [52] the
requisites for the non-recognition of gain or loss under the foregoing provision are as follows:
(a) the transferee is a corporation; (b) the transferee exchanges its shares of stock for
property/ies of the transferor; (c) the transfer is made by a person, acting alone or together with
others, not exceeding four persons; and, (d) as a result of the exchange the transferor, alone or
together with others, not exceeding four, gains control of the transferee. [53] Acting on the 13
January 1997 request filed by FLI, the BIR had, in fact, acknowledged the concurrence of the
foregoing requisites in the Deed of Exchange the former executed with FDC and FAI by issuing
BIR Ruling No. S-34-046-97.[54] With the BIR's reiteration of said ruling upon the request for
clarification filed by FLI,[55] there is also no dispute that said transferee and transferors
subsequently complied with the requirements provided for the non-recognition of gain or loss
from the exchange of property for tax, as provided under Section 34 (c) (2) of the 1993 NIRC.
[56]

Then as now, the CIR argues that taxable gain should be recognized for the exchange
considering that FDC's controlling interest in FLI was actually decreased as a result thereof.For
said purpose, the CIR calls attention to the fact that, prior to the exchange, FDC owned
2,537,358,000 or 67.42% of FLI's 3,763,535,000 outstanding capital stock. Upon the issuance
of 443,094,000 additional FLI shares as a consequence of the exchange and with only
42,217,000 thereof accruing in favor of FDC for a total of 2,579,575,000 shares, said
corporations controlling interest was supposedly reduced to 61%.03 when reckoned from the
transferee's aggregate 4,226,629,000 outstanding shares. Without owning a share from FLI's
initial 3,763,535,000 outstanding shares, on the other hand, FAI's acquisition of 420,877,000
FLI shares as a result of the exchange purportedly resulted in its control of only 9.96% of said
transferee corporation's 4,226,629,000 outstanding shares. On the principle that the transaction
did not qualify as a tax-free exchange under Section 34 (c) (2) of the 1993 NIRC, the CIR
asseverates that taxable gain in the sum of P263,386,921.00 should be recognized on the part of
FDC and in the sum of P3,088,711,367.00 on the part of FAI.[57]

The paucity of merit in the CIR's position is, however, evident from the categorical language of
Section 34 (c) (2) of the 1993 NIRC which provides that gain or loss will not be recognized in
case the exchange of property for stocks results in the control of the transferee by the transferor,
alone or with other transferors not exceeding four persons. Rather than isolating the same as
proposed by the CIR, FDC's 2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000
outstanding shares should, therefore, be appreciated in combination with the 420,877,000 new
shares issued to FAI which represents 9.96% control of said transferee corporation. Together
FDC's 2,579,575,000 shares (61.03%) and FAI's 420,877,000 shares (9.96%) clearly add up to
3,000,452,000 shares or 70.99% of FLI's 4,226,629,000 shares. Since the term "control" is
clearly defined as "ownership of stocks in a corporation possessing at least fifty-one percent of
the total voting power of classes of stocks entitled to one vote" under Section 34 (c) (6) [c] of
the 1993 NIRC, the exchange of property for stocks between FDC FAI and FLI clearly qualify
as a tax-free transaction under paragraph 34 (c) (2) of the same provision.

Against the clear tenor of Section 34(c) (2) of the 1993 NIRC, the CIR cites then Supreme
Court Justice Jose Vitug and CTA Justice Ernesto D. Acosta who, in their book Tax Law and
Jurisprudence, opined that said provision could be inapplicable if control is already vested in
the exchangor prior to exchange.[58] Aside from the fact that that the 10 September 2002
Decision in CTA Case No. 6182 upholding the tax-exempt status of the exchange between FDC,
FAI and FLI was penned by no less than Justice Acosta himself, [59] FDC and FAI significantly
point out that said authors have acknowledged that the position taken by the BIR is to the effect
that "the law would apply even when the exchangor already has control of the corporation at the
time of the exchange."[60] This was confirmed when, apprised in FLI's request for clarification
about the change of percentage of ownership of its outstanding capital stock, the BIR opined as
follows:

Please be informed that regardless of the foregoing, the transferors, Filinvest Development
Corp. and Filinvest Alabang, Inc. still gained control of Filinvest Land, Inc. The term 'control'
shall mean ownership of stocks in a corporation by possessing at least 51% of the total voting
power of all classes of stocks entitled to vote. Control is determined by the amount of stocks
received, i.e., total subscribed, whether for property or for services by the transferor or
transferors. In determining the 51% stock ownership, only those persons who transferred
property for stocks in the same transaction may be counted up to the maximum of five (BIR
Ruling No. 547-93 dated December 29, 1993.[61]

At any rate, it also appears that the supposed reduction of FDC's shares in FLI posited by the
CIR is more apparent than real. As the uncontested owner of 80% of the outstanding shares of
FAI, it cannot be gainsaid that FDC ideally controls the same percentage of the 420,877,000
shares issued to its said co-transferor which, by itself, represents 7.968% of the outstanding
shares of FLI. Considered alongside FDC's 61.03% control of FLI as a consequence of the 29
November 1996 Deed of Transfer, said 7.968% add up to an aggregate of 68.998% of said
transferee corporation's outstanding shares of stock which is evidently still greater than the
67.42% FDC initially held prior to the exchange. This much was admitted by the parties in the
14 February 2001 Stipulation of Facts, Documents and Issues they submitted to the CTA.
[62]
Inasmuch as the combined ownership of FDC and FAI of FLI's outstanding capital stock
adds up to a total of 70.99%, it stands to reason that neither of said transferors can be held liable
for deficiency income taxes the CIR assessed on the supposed gain which resulted from the
subject transfer.

On the other hand, insofar as documentary stamp taxes on loan agreements and promissory
notes are concerned, Section 180 of the NIRC provides follows:

Sec. 180. Stamp tax on all loan agreements, promissory notes, bills of exchange, drafts,
instruments and securities issued by the government or any of its instrumentalities,
certificates of deposit bearing interest and others not payable on sight or demand. On all
loan agreements signed abroad wherein the object of the contract is located or used in the
Philippines; bill of exchange (between points within the Philippines), drafts, instruments and
securities issued by the Government or any of its instrumentalities or certificates of deposits
drawing interest, or orders for the payment of any sum of money otherwise than at sight or on
demand, or on all promissory notes, whether negotiable or non-negotiable, except bank notes
issued for circulation, and on each renewal of any such note, there shall be collected a
documentary stamp tax of Thirty centavos (P0.30) on each two hundred pesos, or fractional
part thereof, of the face value of any such agreement, bill of exchange, draft, certificate of
deposit or note: Provided, That only one documentary stamp tax shall be imposed on either
loan agreement, or promissory notes issued to secure such loan, whichever will yield a higher
tax: Provided however, That loan agreements or promissory notes the aggregate of which does
not exceed Two hundred fifty thousand pesos (P250,000.00) executed by an individual for his
purchase on installment for his personal use or that of his family and not for business, resale,
barter or hire of a house, lot, motor vehicle, appliance or furniture shall be exempt from the
payment of documentary stamp tax provided under this Section.

When read in conjunction with Section 173 of the 1993 NIRC, [63] the foregoing provision
concededly applies to "(a)ll loan agreements, whether made or signed in the Philippines, or
abroad when the obligation or right arises from Philippine sources or the property or object of
the contract is located or used in the Philippines." Correlatively, Section 3 (b) and Section 6 of
Revenue Regulations No. 9-94 provide as follows:

Section 3. Definition of Terms. For purposes of these Regulations, the following term shall
mean:

(b) 'Loan agreement' refers to a contract in writing where one of the parties delivers to another
money or other consumable thing, upon the condition that the same amount of the same kind
and quality shall be paid. The term shall include credit facilities, which may be evidenced by
credit memo, advice or drawings.

The terms 'Loan Agreement" under Section 180 and "Mortgage' under Section 195, both of the
Tax Code, as amended, generally refer to distinct and separate instruments. A loan agreement
shall be taxed under Section 180, while a deed of mortgage shall be taxed under Section 195."

"Section 6. Stamp on all Loan Agreements. All loan agreements whether made or signed in the
Philippines, or abroad when the obligation or right arises from Philippine sources or the
property or object of the contract is located in the Philippines shall be subject to the
documentary stamp tax of thirty centavos (P0.30) on each two hundred pesos, or fractional part
thereof, of the face value of any such agreements, pursuant to Section 180 in relation to Section
173 of the Tax Code.

In cases where no formal agreements or promissory notes have been executed to cover credit
facilities, the documentary stamp tax shall be based on the amount of drawings or availment of
the facilities, which may be evidenced by credit/debit memo, advice or drawings by any form of
check or withdrawal slip, under Section 180 of the Tax Code.
Applying the aforesaid provisions to the case at bench, we find that the instructional letters as
well as the journal and cash vouchers evidencing the advances FDC extended to its affiliates in
1996 and 1997 qualified as loan agreements upon which documentary stamp taxes may be
imposed. In keeping with the caveat attendant to every BIR Ruling to the effect that it is valid
only if the facts claimed by the taxpayer are correct, we find that the CA reversibly erred in
utilizing BIR Ruling No. 116-98, dated 30 July 1998 which, strictly speaking, could be invoked
only by ASB Development Corporation, the taxpayer who sought the same. In said ruling, the
CIR opined that documents like those evidencing the advances FDC extended to its affiliates
are not subject to documentary stamp tax, to wit:

On the matter of whether or not the inter-office memo covering the advances granted by an
affiliate company is subject to documentary stamp tax, it is informed that nothing in
Regulations No. 26 (Documentary Stamp Tax Regulations) and Revenue Regulations No. 9-94
states that the same is subject to documentary stamp tax. Such being the case, said inter-office
memo evidencing the lendings or borrowings which is neither a form of promissory note nor a
certificate of indebtedness issued by the corporation-affiliate or a certificate of obligation,
which are, more or less, categorized as 'securities', is not subject to documentary stamp tax
imposed under Section 180, 174 and 175 of the Tax Code of 1997, respectively. Rather, the
inter-office memo is being prepared for accounting purposes only in order to avoid the co-
mingling of funds of the corporate affiliates.

In its appeal before the CA, the CIR argued that the foregoing ruling was later modified in BIR
Ruling No. 108-99 dated 15 July 1999, which opined that inter-office memos evidencing
lendings or borrowings extended by a corporation to its affiliates are akin to promissory notes,
hence, subject to documentary stamp taxes. [64] In brushing aside the foregoing argument,
however, the CA applied Section 246 of the 1993 NIRC [65] from which proceeds the settled
principle that rulings, circulars, rules and regulations promulgated by the BIR have no
retroactive application if to so apply them would be prejudicial to the taxpayers. [66] Admittedly,
this rule does not apply: (a) where the taxpayer deliberately misstates or omits material facts
from his return or in any document required of him by the Bureau of Internal Revenue; (b)
where the facts subsequently gathered by the Bureau of Internal Revenue are materially
different from the facts on which the ruling is based; or (c) where the taxpayer acted in bad
faith.[67] Not being the taxpayer who, in the first instance, sought a ruling from the CIR,
however, FDC cannot invoke the foregoing principle on non-retroactivity of BIR rulings.
Viewed in the light of the foregoing considerations, we find that both the CTA and the CA erred
in invalidating the assessments issued by the CIR for the deficiency documentary stamp taxes
due on the instructional letters as well as the journal and cash vouchers evidencing the advances
FDC extended to its affiliates in 1996 and 1997. In Assessment Notice No. SP-DST-96-00020-
2000, the CIR correctly assessed the sum of P6,400,693.62 for documentary stamp
tax, P3,999,793.44 in interests and P25,000.00 as compromise penalty, for a total
of P10,425,487.06. Alongside the sum of P4,050,599.62 for documentary stamp tax, the CIR
similarly assessed P1,721,099.78 in interests and P25,000.00 as compromise penalty in
Assessment Notice No. SP-DST-97-00021-2000 or a total of P5,796,699.40. The imposition of
deficiency interest is justified under Sec. 249 (a) and (b) of the NIRC which authorizes the
assessment of the same at the rate of twenty percent (20%), or such higher rate as may be
prescribed by regulations, from the date prescribed for the payment of the unpaid amount of tax
until full payment.[68] The imposition of the compromise penalty is, in turn, warranted under
Sec. 250[69] of the NIRC which prescribes the imposition thereof in case of each failure to file an
information or return, statement or list, or keep any record or supply any information required
on the date prescribed therefor.

To our mind, no reversible error can, finally, be imputed against both the CTA and the CA for
invalidating the Assessment Notice issued by the CIR for the deficiency income taxes FDC is
supposed to have incurred as a consequence of the dilution of its shares in FAC. Anent FDCs
Shareholders Agreement with RHPL, the record shows that the parties were in agreement about
the following factual antecedents narrated in the 14 February 2001 Stipulation of Facts,
Documents and Issues they submitted before the CTA,[70] viz.:

1.11. On November 15, 1996, FDC entered into a Shareholders Agreement (SA) with Reco
Herrera Pte. Ltd. (RHPL) for the formation of a joint venture company named Filinvest Asia
Corporation (FAC) which is based in Singapore (pars. 1.01 and 6.11, Petition, pars. 1 and 7,
Answer).

1.12. FAC, the joint venture company formed by FDC and RHPL, is tasked to develop and
manage the 50% ownership interest of FDC in its PBCom Office Tower Project (Project) with
the Philippine Bank of Communications (par. 6.12, Petition; par. 7, Answer).

1.13. Pursuant to the SA between FDC and RHPL, the equity participation of FDC and RHPL in
FAC was 60% and 40% respectively.
1.14. In accordance with the terms of the SA, FDC subscribed to P500.7 million worth of shares
of stock representing a 60% equity participation in FAC. In turn, RHPL subscribed to P433.8
million worth of shares of stock of FAC representing a 40% equity participation in FAC.

1.15. In payment of its subscription in FAC, FDC executed a Deed of Assignment transferring
to FAC a portion of FDCs right and interests in the Project to the extent of P500.7 million.

1.16. FDC reported a net loss of P190,695,061.00 in its Annual Income Tax Return for the
taxable year 1996.[71]

Alongside the principle that tax revenues are not intended to be liberally construed, [72] the rule is
settled that the findings and conclusions of the CTA are accorded great respect and are generally
upheld by this Court, unless there is a clear showing of a reversible error or an improvident
exercise of authority.[73] Absent showing of such error here, we find no strong and cogent
reasons to depart from said rule with respect to the CTA's finding that no deficiency income tax
can be assessed on the gain on the supposed dilution and/or increase in the value of FDC's
shareholdings in FAC which the CIR, at any rate, failed to establish. Bearing in mind the
meaning of "gross income" as above discussed, it cannot be gainsaid, even then, that a mere
increase or appreciation in the value of said shares cannot be considered income for taxation
purposes. Since a mere advance in the value of the property of a person or corporation in no
sense constitute the income specified in the revenue law, it has been held in the early case
of Fisher vs. Trinidad,[74] that it constitutes and can be treated merely as an increase of
capital. Hence, the CIR has no factual and legal basis in assessing income tax on the increase in
the value of FDC's shareholdings in FAC until the same is actually sold at a profit.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No.
163653 is DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R. No.
72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 is PARTIALLY
GRANTED and the CAs 26 January 2005 Decision in CA-G.R. SP No. 74510 isMODIFIED.
Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-00021-2000
issued for deficiency documentary stamp taxes due on the instructional letters as well as journal
and cash vouchers evidencing the advances FDC extended to its affiliates are declared valid.
The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-00019-2000
and SP-INC-97-0027-2000 issued for deficiency income assessed on (a) the arms-length
interest from said advances; (b) the gain from FDCs Deed of Exchange with FAI and FLI; and
(c) income from the dilution resulting from FDCs Shareholders Agreement with RHPL is,
however, upheld.
SO ORDERED.
Gregory v. Helvering No. 127
Argued December 4, 5, 1934
Decided January 7, 1935
293 U.S. 465
CERTIORARI TO THE CIRCUIT COURT OF APPEALS
FOR THE SECOND CIRCUIT
Syllabus
1. A corporation wholly owned by a taxpayer transferred 1000 shares of stock in another
corporation held by it among its assets to a new corporation, which thereupon issued all of its
shares to the
Page 293 U. S. 466
taxpayer. Within a few days, the new corporation was dissolved and was liquidated by the
distribution of the 1000 shares to the taxpayer, who immediately sold them for her individual
profit. No other business was transacted, or intended to be transacted, by the new corporation.
The whole plan was designed to conform to 112 of the Revenue Act of 1928 as a
"reorganization," but for the sole purpose of transferring the shares in question to the taxpayer,
with a resulting tax liability less than that which would have ensued from a direct transfer by
way of dividend. Held: while the plan conformed to the terms of the statute, there was no
reorganization within the intent of the statute. P. 293 U. S. 468.
2. By means which the law permits, a taxpayer has the right to decrease the amount of what
otherwise would be his taxes, or altogether to avoid them. P. 293 U. S. 469.
3. The rule which excludes from consideration the motive of tax avoidance is not pertinent to
the situation here, because the transaction upon its face lies outside the plain intent of the
statute. P. 293 U. S. 470.
69 F.2d 809 affirmed.
Certiorari to review a judgment reversing a decision of the Board of Tax Appeals, 27 B.T.A.
223, which set aside an order of the Commissioner determining a deficiency in income tax.
Page 293 U. S. 467
MR. JUSTICE SUTHERLAND delivered the opinion of the Court.
Petitioner, in 1928, was the owner of all the stock of United Mortgage Corporation. That
corporation held among its assets 1,000 shares of the Monitor Securities Corporation. For the
sole purpose of procuring a transfer of these shares to herself in order to sell them for her
individual profit, and at the same time, diminish the amount of income tax which would result
from a direct transfer by way of dividend, she sought to bring about a "reorganization" under
112(g) of the Revenue Act of 1928, c. 852, 45 Stat. 791, 816, 818, set forth later in this opinion.
To that end, she caused the Averill Corporation to be organized under the laws of Delaware on
September 18, 1928. Three days later, the United Mortgage Corporation transferred to the
Averill Corporation the 1,000 shares of Monitor stock, for which all the shares of the Averill
Corporation were issued to the petitioner. On September 24, the Averill Corporation was
dissolved, and liquidated by distributing all its assets, namely, the Monitor shares, to the
petitioner. No other business was ever transacted, or intended to be transacted, by that company.
Petitioner immediately sold the Monitor shares for $133,333.33. She returned for taxation, as
capital net gain, the sum of $76,007.88, based upon an apportioned cost of $57,325.45. Further
details are unnecessary. It is not disputed that, if the interposition of the so-called reorganization
was ineffective, petitioner became liable for a much larger tax as a result of the transaction.
The Commissioner of Internal Revenue, being of opinion that the reorganization attempted was
without substance and must be disregarded, held that petitioner was liable for a tax as though
the United corporation had paid her a dividend consisting of the amount realized from the sale
of the Monitor shares. In a proceeding before the Board of Tax Appeals, that body rejected the
commissioner's view and upheld that of petitioner. 27 B.T.A. 223. Upon a review of the latter
decision, the Circuit Court of Appeals sustained the commissioner and reversed the board,
holding that there had been no "reorganization" within the meaning of the statute. 69 F.2d 809.
Petitioner applied to this Court for a writ of certiorari, which the government, considering the
question one of importance, did not oppose. We granted the writ.
Section 112 of the Revenue Act of 1928 deals with the subject of gain or loss resulting from the
sale or exchange of property. Such gain or loss is to be recognized in computing the tax, except
as provided in that section. The provisions of the section, so far as they are pertinent to the
question here presented, follow:
"Sec. 112. (g) Distribution of Stock on Reorganization. If there is distributed, in pursuance of a
plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or
securities in such corporation or in another corporation a party to the reorganization, without the
surrender by such shareholder of stock or securities in such a corporation, no gain to the
distributee from the receipt of such stock of securities shall be recognized. . . ."
"(i) Definition of Reorganization. -- As used in this section . . ."
"(1) The term 'reorganization' means . . . (B) a transfer by a corporation of all or a part of its
assets to another corporation if immediately after the transfer the transferor or its stockholders
or both are in control of the corporation to which the assets are transferred. . . ."
It is earnestly contended on behalf of the taxpayer that, since every element required by the
foregoing subdivision (B) is to be found in what was done, a statutory reorganization was
effected, and that the motive of the taxpayer thereby to escape payment of a tax will not alter
the result
Page 293 U. S. 469
or make unlawful what the statute allows. It is quite true that, if a reorganization in reality was
effected within the meaning of subdivision (B), the ulterior purpose mentioned will be
disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be
his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. United
States v. Isham, 17 Wall. 496, 84 U. S. 506; Superior Oil Co. v. Mississippi, 280 U. S. 390, 280
U. S. 395-396;Jones v. Helvering, 63 App.D.C. 204, 71 F.2d 214, 217. But the question for
determination is whether what was done, apart from the tax motive, was the thing which the
statute intended. The reasoning of the court below in justification of a negative answer leaves
little to be said.
When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a
transfer made "in pursuance of a plan of reorganization" [ 112(g)] of corporate business, and
not a transfer of assets by one corporation to another in pursuance of a plan having no relation
to the business of either, as plainly is the case here. Putting aside, then, the question of motive in
respect of taxation altogether, and fixing the character of the proceeding by what actually
occurred, what do we find? Simply an operation having no business or corporate purpose -- a
mere device which put on the form of a corporate reorganization as a disguise for concealing its
real character, and the sole object and accomplishment of which was the consummation of a
preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel
of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But
that corporation was nothing more than a contrivance to the end last described. It was brought
into existence for no other purpose; it performed, as it was intended from the beginning it
should perform, no other function.
When that limited function had been exercised, it immediately was put to death.
In these circumstances, the facts speak for themselves, and are susceptible of but one
interpretation. The whole undertaking, though conducted according to the terms of subdivision
(B), was in fact an elaborate and devious form of conveyance masquerading as a corporate
reorganization, and nothing else. The rule which excludes from consideration the motive of tax
avoidance is not pertinent to the situation, because the transaction, upon its face, lies outside the
plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to
deprive the statutory provision in question of all serious purpose.
Judgment affirmed.