PRE-WEEK REVIEW NOTES

PAGE 69

2001 PRE-WEEK REVIEW NOTES

TAXATIONBy

Prof. Abelardo T. Domondon

HOW TO USE THESE NOTES:

These Notes in the form of review questions and textual materials were specially prepared by the author for the exclusive use of Bar Candidates who attended his lectures in Taxation. They are to be used as supplements to his Bar Reviewer in Taxation, Vols, I and II.

The purpose of these Notes is to test the candidates ability to answer hypothetical questions as well as those based on selected cases decided by the Supreme Court during the period 1990-2000.

It is suggested that the reviewee should cover the suggested answers while reading the questions. This should force him to recall the applicable law and jurisprudence. If there is time, the answers should be written on a grade school notebook using the sign pen to be used during the actual exams. Each question should be answered within a span of nine (9) minutes only. Check your answers referring to the SUGGESTED ANSWERS.

Do not MEMORIZE the suggested answers. They were purposely made to be lengthy to serve as explanatory devices. This is so, because the reviewee does not have time any more to refer back to the review materials. If the candidate still could not understand the concepts after reading these notes, then refer to the authors Bar Reviewer in Taxation, Vols, I and II.

IMPORTANT: The questions asked in the Bar may not be worded in the same manner as the questions shown in these notes, therefore the reviewee is warned that it should be the concepts shown in the questions and suggestions that he should master and not the questions and answers per se. Be specially careful where the Bar questions are variations of the questions included because the answers may be different. It is suggested that particular attention be given to questions and areas which are marked ***

WARNING:

These materials are copyrighted and are only authorized for the use of bar candidates who have attended the Tax Review lectures of Prof. Domondon and others he has personally authorized. These include those who have attended the lectures conducted by Primus Management Unlimited Services, Inc., held at the Asian Social Institute, Inc., Lex Bar Reviews and Seminars, Inc., University of the Philippines, University of Santo Tomas, Ateneo de Manila University, San Sebastian College-Recolletos and Far Eastern University. Students of other schools and reviewees of other review centers are not authorized to use these notes. These materials are copyrighted. UNAUTHORIZED USERS SHALL BE SUBJECT TO THE LAW OF KARMA SUCH THAT THEY WILL NEVER PASS THE BAR.

GENERAL PRINCIPLES OF TAXATION

*** 1. When may the power to tax include the power to destroy? When is exercise of the power to tax not destructive of taxpayers property?

SUGGESTED ANSWER:

The power to tax includes the power to destroy, where the tax is a valid tax. This is so because a taxpayer could not seek the nullification of the valid tax solely upon the premise that the tax will impoverish him.

The exercise of the power to tax is not destructive of taxpayers property where it is an invalid tax, which violates the inherent or constitutional limitations. This is so because there is a sympathetic court that shall come to the succor of the taxpayer and declare such tax as invalid.

2. Discuss the concept of interpretation of tax laws as differentiated from the concept of interpretation of tax exemption laws.

SUGGESTED ANSWER: A tax cannot be imposed unless it is supported by the clear and express language of a statute. (Davao Gulf Lumber Corporation v. Commissioner of Internal Revenue, et al., 293 SCRA 76, 88) In short, in case of doubt, tax laws must be construed strictly against the State and liberally in favor of the taxpayer. This is because taxes, as burdens which must be endured by the taxpayer, should not be presumed to go beyond what the law expressly and clearly declares. (Lincoln Philippine Life Insurance Company, Inc., etc., v. Court of Appeals, et al., 293 SCRA 92, 99)

On the other hand, when a tax is unquestionably imposed, a claim of exemption form tax payments must be clearly shown and based on language in the law too plain to be mistaken. (Davao Gulf Lumber Corporation, supra)

NOTES AND COMMENTS: The above concepts are also the holding in (Commissioner of Internal Revenue v. Court of Appeals, et al., G.R. No. 107135, prom. February 23, 1999) This is the CENVOCO case.

Furthermore, a reversal of a BIR ruling favorable to a taxpayer would not necessarily create a perpetual exemption in his favor, for after all the government is never estopped from collecting taxes because of mistakes or errors on the part of its agents. (Ibid.)

***3. What do you understand by the inherent and constitutional limitations as being restrictive of the otherwise unlimited and plenary power of taxation?

SUGGESTED ANSWER:

The inherent and constitutional limitations to the power of taxation are safeguards which would prevent abuse in the exercise of this otherwise unlimited and plenary power.

***4. What are the inherent limitations to the power of taxation?

SUGGESTED ANSWER:

a. PUBLIC PURPOSE. The tax revenues must be utilized for the benefit of the community in general. An alternative meaning is that tax proceeds should be utilized only to attain the objectives of government.

b. NO IMPROPER DELEGATION OF LEGISLATIVE AUTHORITY. The power of taxation is exercised by the legislature whose members are the mere delegates of the people. This power could not therefore be delegated by the legislature to other departments of government, like the executive.

c. TERRITORIALITY. The power to tax should be exercised only within the territorial boundaries of the taxing authority.

d. GOVERNMENT EXEMPTION SHOULD BE RECOGNIZED. This is so in order to reduce the amount of money the government is handling. There is verity in the maxim, For the government, exemption is the rule and taxation is the exception.

e. COMITY. Respect should be accorded to other sovereign nations. The power of taxation is a high prerogative of sovereignty. The properties of other sovereign nations within the territory of the taxing authority should not be subject to taxation as a measure of respect to a co-equal.

***5. What are the constitutional limitations on the power of taxation?

SUGGESTED ANSWER:

***GENERAL OR INDIRECT CONSTITUTIONAL LIMITATIONS:

a. Due process clause;

b. Equal protection clause;

c. Freedom of the press;

d. Religious freedom;

e. Non-impairment clause;

f. Law-making process:

1) Bill should embrace only one subject expressed in the title thereof;

2) Three (3) readings on three separate days;

3) Printed copies in final form distributed three (3) days before passage.

g. Presidential power to grant reprieves, commutations and pardons and remittal of fines and forfeiture after conviction by final judgment.

***SPECIFIC OR DIRECT CONSTITUTIONAL LIMITATIONS:

a. No imprisonment for non-payment of a poll tax;

b. Taxation shall be uniform and equitable;

c. Congress shall evolve a progressive system of taxation;

d. All appropriation, revenue or tariff bills shall originate exclusively in the House of Representatives, but the Senate may propose and concur with amendments;

e. The President shall have the power to veto any particular item or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to which he does not object;

f. Delegated power of the President to impose tariff rates, import and export quotas, tonnage and wharfage dues:

1) Delegation by Congress

2) Through a law

3) Subject to Congressional limits and restrictions

4) Within the framework of national development program.

g. Tax exemption of charitable institutions, churches, parsonages and convents appurtenant thereto, mosques, and all lands, buildings and improvements of all kinds actually, directly and exclusively used for religious, charitable or educational purposes;

h. No tax exemption without the concurrence of majority vote of all members of Congress;

i. No use of public money or property for religious purposes except if priest is assigned to the armed forces, penal institutions, government orphanage or leprosarium;

j. Money collected on tax levied for a special purpose to be used only for such purpose, balance if any, to general funds;

k. The Supreme Court's power to review judgments or orders of lower courts in all cases involving the legality of any tax, impose, assessment or toll or the legality of any penalty imposed in relation to the above;

l. Authority of local government units to create their own sources of revenue, to levy taxes, fees and other charges subject to guidelines and limitations imposed by Congress consistent with the basic policy of local autonomy;

m. Automatic release of local government's just share in national taxes;

n. Tax exemption of all revenues and assets of non-stock, non-profit educational institutions used actually, directly and exclusively for educational purposes;

o. Tax exemption of all revenues and assets of proprietary or cooperative educational institutions subject to limitations provided by law including restrictions on dividends and provisions for reinvestment of profits;

p. Tax exemption of grants, endowments, donations or contributions used actually, directly and exclusively for educational purposes subject to conditions prescribed by law.

6. Republic Act No. 7227 created the Subic Special Economic Zone (SSEZ), and provides that the SSEZ shall be managed as a separate customs territory with such incentives as tax and duty-free importations of raw materials, capital and equipment. It further provides that no taxes, local and national, shall be imposed within the SSEZ, but in lieu thereof, 3% of the gross income earned by businesses therein shall be remitted to the National Government with 1% each to the local government units affected by the declaration of the zone in proportion to their population area and other factors. In addition, a development fund of 1% of the gross income earned by all businesses within the SSEZ shall be utilized for the development of municipalities outside Olongapo City and the Municipality of Subic and other municipalities contiguous to the base areas.

On June 10, 1993, President Ramos issued Executive Order No. 97 clarifying that tax and import duty-free importations shall apply only to raw materials, capital goods and equipment brought in by business enterprises in the SSEZ. On June 19, 1993, President Ramos issued Executive Order No, 97-A specifying that the secured areas that shall be completely tax and duty-free in the SSEZFPZ consists of the presently fenced-in former Subic Naval Base.

Executive No. 97-A is challenged for being violative of the equal protection of the law clause because of its bias in favor of big investors. Is there merit in the challenge ? Explain briefly.

SUGGESTED ANSWER: No. Equal protection of the law clause is subject to reasonable classification. If the groupings are characterized by substantial distinctions that make real differences, one class may be treated and regulated differently from another. The classification must also be germane to the purpose of the law and must apply to all those belonging to the same class.

***Classification, to be valid, must (1) rest on substantial distinctions, (2) be germane to the purpose of the law, (3) not be limited to existing conditions only, and (4) apply equally to all members of the same class.

In issuing E.O. No. 97-A delimiting incentives within the confines of the former Subic military base, the President reasonably made a classification that is germane to the purpose of Republic Act No. 7227. The purpose of Republic Act No. 7227 is to accelerate the conversion of military reservations into productive uses. It was reasonable for the President to have delimited the application of some incentives to the confines of the former Subic military base. The classification is therefore germane to the purposes of the law.

There are substantial differences between big investors being enticed to the secured area and the business operators outside that are in accord with the equal protection clause that does not require territorial uniformity of laws. Of course the outsiders, possessing the requisite investment capital can always avail of the same benefits by channeling their resources or business operations into the fenced-off free port zone.

The classification set forth by E.O. No. 97-A does not merely apply to existing conditions. As laid down in R.A. No. 7227, the objective is to establish a self-sustaining, industrial, commercial, financial and investment center in the area. There will, therefore, be a long-term difference between such investment center and the areas outside it.

The classification applies equally to al the resident individuals and businesses within the secured area. The residents, being in like circumstances o contributing directly to the achievement of the end purpose of the law, are not categorized further. Instead, they are similarly treated, both in privileges granted and obligations required. (Tiu, et al., v. Court of Appeals, et al., G.R. No. 127410, January 20, 1999)

7. On July 1, 1993, or a month after the enactment and two days before the effectivity of Republic Act No. 7654, the BIR issued RMC No. 37-93 which considered Hope Luxury, Premium More and Champion cigarettes being manufactured by Fortune Tobacco corporation as locally manufactured cigarettes bearing a foreign brand subject to the higher 55% ad valorem tax on cigarettes.

The following day, on July 2, 1993, at about 5:50 p.m., the BIR sent via fax a copy of RMC No. 37-93 to Fortune Tobacco but was addressed to no one in particular. On July 15, 1993 Fortune Tobacco received, by ordinary mail, a certified xerox copy of RMC No. 37-93.

Fortune Tobacco now claims that its constitutional right to due process was violated because there was no hearing before BIR issued RMC No. 37-93. Do your agree ? Explain.

SUGGESTED ANSWER:

Yes. There was a violation of Fortune Tobaccos right to due process.

BIR issued RMC No. 37-93 for the purpose of placing Hope Luxury, Premium More and Champion within the scope of the amendatory law and subject them to the increased tax rate.

In so doing, the BIR did not simply interpret the law, it issued a legislative rule which is in the nature of subordinate legislation, designed to implement a primary legislation by providing the details thereof. In the same way that laws must have the benefit of public hearing, it is generally required that before a legislative rule is adopted there must be a hearing and publication as required under the Administrative Code.

On the other hand, if what is issued is merely an interpretative rule (which is not the rule issued in this case),no hearing or publication is required since an interpretative rule is designed merely to provide guidelines of the law which the administrative agency is in charge of enforcing. (Commissioner of Internal Revenue v. Court of Appeals, et al., 261 SCRA 236 )

8. It is contended that Expanded Value-Added Tax is violative of the constitutional rule that taxes should be uniform and equitable. It is likewise advanced that the EVAT is oppressive, discriminatory, and unjust. How were these objections disposed of in the case of Tolentino v. Secretary of Finance and companion cases, 249 SCRA 628 (1995) ?

SUGGESTED ANSWER:

***a. It is inherent in the power to tax that the state be free to select the subjects of taxation and it has been repeatedly held that inequalities which result from a singling out of one particular class for taxation, or exemption infringe no constitutional limitation. Thus, the EVAT on certain goods and services only, but not on others, do not violate the rule on uniformity and equitableness.

***b. Equality and uniformity of taxation means that all taxable articles or kinds of property of the same class be taxed at the same rate. The taxing power has the authority to make reasonable and natural classifications for purposes of taxation. To satisfy the requirement of uniformity and equitableness, it is enough that the statute or ordinance applies equally to all persons, forms and organizations placed in a similar situation.

c. The EVAT is uniform because the tax is applied similarly on all goods and services sold to the public, which is not exempt, at the constant rate of 0% or 10%.

d. The EVAT is equitable because it is imposed only on sale of goods and services by persons engaged in business with an annual gross sales as determined by the law.

Small corner sari-sari stores are consequently exempt from its application. Likewise exempt from the tax are sales of farm and marine products. Thus, the cost of basic food and other necessities, spared as they are from EVAT, are expected to be relatively lower and within the reach of the general public.

9. On August 5, 1998, BIR agents acting upon a regularly issued Mission Order examined the books of account of various jewelers engaged in the manufacture of jewelry and allied undertakings were examined and investigated for excise tax purposes. Among these firms were Hans, Miladay, Mercelles, etc.

Subsequently, the jewelers and their association filed with the Regional Trial Court a petition for declaratory relief praying that certain provisions of the NIRC imposing 20% excise tax on jewelry, pearls and other precious stones, and provisions of the Tariff and Customs Code imposing three to ten percent (3% to 10%) tariff and customs duty on natural and cultured pearls and precious or semi-precious stones, be declared unconstitutional and null and void.

The jewelers likewise presented an exhaustive study on the tax rates on jewelry levied by different Asian countries.

The trial court declared the questioned provisions as inoperative and without force and effect insofar as the jewelers are concerned. The trial court made the observation that indeed government tax policy treats jewelry as non-essential items, and therefore, taxed heavily; that the present tariff and tax structure increase manufacturing cost and renders the local jewelry manufacturers uncompetitive against other countries. Was there legal basis for the trial court's declaration ? Explain.

SUGGESTED ANSWER: No. There was no legal basis for the following reasons:

a. The trial judge encroached upon matters properly falling within the province of legislative functions. In making the aforesaid observations, the trial judge overlooked the fact that such matters are not for him to decide. There are reasons why jewelry, a non-essential item, is taxed as it is in this country and these reasons, deliberated upon by the legislature are beyond the reach of judicial questioning.

b. The trial court is not the proper forum for the ventilation of the issues raised by the jewelers. It is the legislature to which relief must be sought, because with the legislature primarily lies the discretion to determine the nature (kind), object (purpose), extent (rate), coverage (subjects) and situs (place) of taxation. The judiciary cannot freely delve into those matters which, by constitutional fiat, rightly rest on legislative judgment.

c. The tax rates of other countries should not be used as a yardstick, in determining what may be the proper subjects of taxation in our own country. It should be pointed out that in imposing the aforementioned taxes and duties, the State, acting though the legislative and executive branches, is exercising its sovereign prerogative. It is inherent in the power to tax that the State be free to select the subjects of taxation, and it has been repeatedly held that, "inequalities which result from a singling out of one particular class of taxation, or exemption, infringe no constitutional limitation." (Commissioner of Internal Revenue, et al., v. Santos, et al., 277 SCRA 617)

***10. A fixed annual license fee on those engaged in the business of general enterprise was also imposed on the sale of bibles by a religious sect. Is this valid ?

SUGGESTED ANSWER: No, because it violates the constitutionally guaranteed freedom of the press, and of religion..

As a license fee is fixed in amount and unrelated to the receipts of the taxpayer, such a license fee, when applied to a religious sect is actually imposed as a condition for the free exercise of religion. A license fee restrains in advance those constitutional liberties of press and religion and inevitably tends to suppress their exercise. ***11. The EVAT Law imposes a VAT registration fee of P1,000.00 on non-VAT enterprises which includes among others, religious sects which sells and distributes religious literature. Is this violative of religious freedom ?

SUGGESTED ANSWER: No. The P1,000.00 VAT registration fee, although a fixed amount is not imposed for the exercise of a privilege but only for the purpose of defraying part of the cost of registration.

The registration requirement is a central feature of the VAT system. It is designed to provide a record of tax credits because any person who is subject to the payment of the VAT pays an input tax, even as he collects an output tax on sales made or services rendered. The registration fee is thus more of an administrative fee, one not imposed on the exercise of a privilege, much less a constitutional right. (Tolentino v. Secretary of Finance, et al., and companion cases, 235 SCRA 630)

***12. Airlines, Inc. was granted a legislative franchise to operate scheduled flight services between Manila and Cebu and vice-versa. It was subject to a franchise tax of 2% qualified by the magic words, which shall be in lieu of all taxes. Subsequently, Congress enacted Republic Act No. 7716, the Expanded Value-Added Tax (EVAT) Law which imposes a 10% VAT on all services offered by Airlines, Inc.

Airlines, Inc. assails the validity of R.A. No. 7716 for being violative of the non-impairment clause. It cites Commissioner of Internal Revenue v. Lingayen Gulf Electric Power Co., Inc., et al., 164 SCRA 27 (1988) where it was held that the imposition of a tax on franchise holders with the magic words is violative of the non-impairment clause.

The Supreme Court in the Lingayen Gulf case held that charters or special laws granted by the legislature are in the nature of private contracts. Rule on the contention of Airlines, Inc.

SUGGESTED ANSWER: The EVAT does not violate the non-impairment clause. Tolentino v. Secretary of Finance and its companion cases, 235 SCRA 630, 249 SCRA.628, provides the reasons why there is no violation:

a. Article XII, Sec. 11 of the Constitution provides that the grant of a franchise for the operation of a public utility is subject to amendment. alteration or repeal by Congress when the common good requires;

b. Not only existing laws but also the reservation of essential attributes of sovereignty is read into contracts as a postulate of the legal order;

c. Contracts must be understood as having been made in reference to the possible exercise of the rightful authority of the government and no obligation of contract can extend to defeat that authority;

d. A lawful tax on a new subject, or an increased tax on an old one, does not interfere with a contract or impairs its obligation, within the meaning of the constitution. Even though such taxation may affect particular contracts, as it may increase the debt of one person and lessen the security of another, or may impose additional burdens upon one class and release the burdens of another, still the tax must be paid unless prohibited by the constitution, nor can it be said that it impairs the obligations of any existing contract in its true and legal sense.

***13. Meralco was granted a franchise to operate an electric light and power service in Calamba, Laguna sometime in 1983 under P.D. No. 551. Under the franchise Meralco pays 2% franchise tax on of its gross receipts and any law to the contrary notwithstanding be in lieu of all taxes and assessments of whatever nature imposed by any national or local authority or earnings, receipts, income and privilege of generation, distribution and sale of electric current. Pursuant to the Local Government Code, the province of Laguna enacted an ordinance imposing a franchise of 50% of 1% of the gross annual receipts of business enjoying a franchise realized during the preceding calendar year within the province including cities located therein. Rule on the validity of the tax ordinance.

SUGGESTED ANSWER: The tax ordinance is valid. Under the now prevailing Constitution, where there is neither a grant nor prohibition by statute, the tax power must be deemed to exist although Congress may provide statutory limitations and guidelines. The basic rationale for the current rule is to safeguard the viability and self-sufficiency of local government units by directly granting them general and broad tax powers.

The Local Government Code explicitly authorizes provinces and cities, notwithstanding any exemption granted by any law or other special law to impose a tax on businesses enjoying a franchise. Indicative of the legislative intent to carry out the constitutional mandate of vesting broad tax powers to local government units, the Local Government Code has withdrawn tax exemptions or incentives theretofore enjoyed by certain entities.

In addition, the Local Government Code contains a general repealing clause. The phrase in lieu of all taxes has to give way to the peremptory language of the Local Government Code which specifically provides for the withdrawal of all exemptions. The Court has viewed its previous rulings as laying stress on the legislative intent of the amendatory law whether the tax exemption privilege is to be withdrawn or not rather than on whether the law can or cannot withdraw the tax exemption, without violating the constitution. (Manila Electric Company v. Province of Laguna, et al., G.R. No. 131359, May 5, 1999)

The Local Government Code provisions on withdrawal of tax exemptions prescribes the general rule, viz. the tax exemptions or incentives granted to or presently enjoyed by natural or juridical persons are withdrawn with the effectivity of the Local Government Code except with respect to those expressly enumerated. (City Government of San Pablo, Laguna, et al., v. Reyes, et al., G.R. No. 127708, March 25, 1999)

NOTES AND COMMENTS: It is possible that the Bar question might come from one of the following areas:

***Power of local governments to tax. Local governments do not have the inherent power to tax except to the extent that such power might be delegated to them either by the basic law or statute. Presently, under Article X of the 1987 Constitution a general delegation of that power has been given in favor of local government units.

Nevertheless, the fundamental law did not intend the delegation to be absolute and unconditional, the constitutional objective obviously is to ensure that, while local government units are being strengthened and made more autonomous, the legislature must still see to it that:

a. the taxpayer will not be over-burdened or saddled with multiple and unreasonable impositions;

b. each local government unit will have its fair share of available resources;

c. the resources of the national government will be unduly disturbed; and

d. local taxation will be fair, uniform and just. (Manila Electric Company v. Province of Laguna, et al., G.R. No. 131359, May 5, 1999)

The Manila Electric Company case doctrine reversed the holding in City Government of San Pablo, Laguna, et al., v. Reyes, et al., G.R. No. 127708, March 25, 1999 that municipal corporations are vested by the Constitution with the power to tax. It may be exercised by local legislative bodies, no longer by virtue of a valid delegation as before, but pursuant to direct authority conferred by the Constitution.

The non-impairment clause. Questionable ruling. The non-impairment clause cannot be invoked by franchises, as franchises are always subject to police power, as well as the power to tax (?), which like police power cannot be contracted away (?). (City Government of San Pablo, Laguna, et al., v. Reyes, et al., G.R. No. 127708, March 25, 1999) The author considers this ruling to be questionable because the taxing power is inferior to the nonimpairment clause.

While the Court has, not too infrequently, referred to tax exemptions contained in special franchises as being in the nature of contracts and a part of the inducement for carrying out the franchise, these exemptions, nevertheless far from being strictly contractual in nature.

***Constitutional tax exemptions, in the real sense of the term and where the non-impairment clause of the Constitution can rightly be invoked, are those agreed to by the taxing authority in contracts, such as those contained in government bonds or debentures, lawfully entered into by them under enabling laws in which the government, acting in its private capacity sheds its cloak of authority and waives its government immunity.

Truly, tax exemptions of this kind may not be revoked without impairing the obligations of contracts. A franchise partakes of the nature of a grant which is not beyond the purview of the non-impairment clause. Indeed the 1987 Constitution like its precursors the 1935 and the 1973 Constitutions is explicit that no franchise for the operation of a public utility shall be granted except under the condition that such privilege shall be subject to amendment, alteration or repeal by Congress as and when the common good so requires. (Manila Electric Company v. Province of Laguna, et al., G.R. No. 131359, May 5, 1999)

The reader should take note of the conflicting doctrines espoused by the Manila Electric case and the City Government of San Pablo, Laguna case. It may interest the reader also to know that the ponente in the Manila Electric case is Justice Jose Vitug, while the ponente in the City Government of San Pablo, Laguna is Justice Minerva Gonzaga-Reyes.

***14. What is the concept of double taxation ?

a. MEANING. In its generic sense, this means taxing the same subject or object twice during the same taxable period. In its particular sense, it may mean direct duplicate taxation, which is prohibited under the constitution because it violates the concept of equal protection, uniformity and equitableness of taxation. Indirect duplicate taxation is not anathemized by the above constitutional limitations.

b. ELEMENTS OF DIRECT DUPLICATE TAXATION:

1) Same

a) Subject or object is taxed twice

b) Taxing authority

c) Taxing purpose

d) Taxing period

2) Taxing all of the subjects or objects for the first time without taxing all

of them for the second time.

If any of the elements are absent then there is indirect duplicate taxation which is not prohibited by the constitution.

NOTES AND COMMENTS: There may be a problem on double taxation, including compensation and set-off.

***15. Define international juridical double taxation.

SUGGESTED ANSWER: The imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter and for identical grounds.

Double taxation usually takes place when a person is a resident of a contracting state and derives income from or owns capital in, the other contracting state and both states impose tax on that income or capital. (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., et al., G.R. No. 127105, prom. June 25, 1999

***16. What are the methods for avoidance of double taxation ? Explain each briefly but comprehensively.

SUGGESTED ANSWER: The following are the methods of avoiding double taxation:

a. Tax treaties which exempts foreign nationals from local taxation and local nationals from foreign taxation under the principle of reciprocity.

b. Tax credits where foreign taxes are allowed as deductions from local taxes that are due to be paid.

c. Allowing foreign taxes as a deduction from gross income.

NOTES AND COMMENTS:

a. Purpose of tax treaties. To reconcile the national fiscal legislations of the contracting parties in order to help the taxpayer avoid simultaneous taxation in two different jurisdictions. More precisely, the tax conventions are drafted with a view towards the elimination of international juridical double taxation.

b. Rationale for avoiding double taxation. To encourage the free flow of goods and services and the movement of capital, technology and persons between countries, conditions deemed vital in creating robust and dynamic economies. Foreign investments will only thrive in a fairly predictable and reasonable international investment climate and the protection against double taxation is crucial in creating such a climate.

***c. Methods resorted to by a tax treaty in order to eliminate double taxation:

First Method: It sets out the respective rights to tax of the state of source or situs and of the state of residence with regard to certain classes of income or capital. In some cases, an exclusive right to tax is conferred on one of the contracting states; however, for other items of income or capital, both states are given the right to tax, although the amount of tax that may be imposed by the state of source is limited.

Second Method: The state of source is given a full or limited right to tax together with the state of residence. In this case, the treaties make it incumbent upon the state of residence to allow relief in order to avoid double taxation. Two methods of relief are used:

1) The exemption method the income or capital which is taxable in the state of source or situs is exempted in the state of residence, although in some instances it may be taken into account in determining the rate of tax applicable to the taxpayers remaining income or capital.

2) The credit method although the income or capital which is taxed in the state of source is still taxable in the state of residence, the tax paid in the former is credited against the tax levied in the latter. (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., et al., G.R. No. 127105, prom. June 25, 1999)

Difference between the exemption method and the credit method. The exemption method focuses on income or capital itself while the credit method focuses upon the tax. . (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., et al., G.R. No. 127105, prom. June 25, 1999)

***17. The RP-West Germany Tax Treaty provides a 10% tax on royalties. but expressly allows against German income and corporate tax of 20% of the gross royalties paid under the law of the Philippines. On the other hand the RP-US Tax Treaty does not provide for a similar tax crediting. Thus, the tax on royalties earned by U.S. firms in the Philippines may either be of three rates: 25 percent of the gross amount of the royalties; 15 percent when the royalties are paid by a corporation registered with the Philippine Board of Investments and engaged in preferred areas of activities; or the lowest rate of Philippine tax that may be imposed on royalties of the same kind paid under similar circumstances to a resident of a third state.

May U.S. Corporations claim entitlement to the most favored nation tax rate of 10% on royalties as provided in the RP-US Tax Treaty in relation to the RP-West Germany Tax Treaty ? Explain with reasons.

SUGGESTED ANSWER: No. The entitlement of the 10% rate by U.S. firms despite the absence of a matching credit (20% for royalties) would derogate from the design behind the most favored nation clause to grant equality of international treatment since the tax burden laid upon the income of the investor is not the same in the two countries. The similarity in the circumstances of payment of taxes is a condition for the enjoyment of the most favored nation treatment precisely to underscore the need for equality of treatment. (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., et al., G.R. No. 127105, prom. June 25, 1999)

NOTES AND COMMENTS:

a. Intention behind adoption of provision on relief from double taxation. The intention should be considered in the light of the purpose behind the most favored nation (MFN) clause which is to grant to the contracting party treatment not less favorable than which has been or may be granted to the most favored among other countries.

The MFN is intended to establish the principle of equality of international treatment by providing that the citizens or subjects of the contracting nations may enjoy privileges accorded by either party to those of the most favored nation. The essence of the principle is to allow the taxpayer in one state to avail of more liberal provisions granted in another tax treaty to which the country of residence of such taxpayer is also a party provided that the subject matter of taxation is the same as that in the tax treaty under which the taxpayer is liable. (Commissioner of Internal Revenue v. S.C. Johnson and Son, Inc., et al., G.R. No. 127105, prom. June 25, 1999)

18. The Expanded Value-Added Tax Law is an indirect tax which may be considered as regressive in character. It is a fixed tax therefore the lower is the income the taxes that are paid are proportionately higher. Is this violative of the constitution which mandates that Congress shall evolve a progressive system of taxation ? Explain.

SUGGESTED ANSWER: There is no violation of the constitutional mandate for the following reasons:

a. The mandate to Congress is not to prescribe but to evolve a progressive system of taxation. Otherwise, sales taxes which perhaps are the oldest form of indirect taxes, would have been prohibited with the proclamation of the constitutional provision. Sales taxes are also regressive.

b. The Constitution does not really prohibit the imposition of indirect taxes which, like the VAT, are regressive. The constitutional provision means simply that indirect taxes should be minimized.

c. Resort to indirect taxes should be minimized but not avoided entirely because it is difficult, if not impossible, to avoid imposing such taxes according to the taxpayers ability to pay.

In the case of VAT, the law minimizes the regressive effects of this imposition by providing for zero rating of certain transactions while granting exemptions to other transactions. The transactions which are subject to VAT are those which involve goods and services which are used or availed of mainly by higher income groups. (Tolentino v. Secretary of Finance and companion cases, 249 SCRA 628) ***19. The Constitution requires that all revenue bills shall originate exclusively from the House of Representatives. Was this violated when the EVAT bill that originated from the House did not become the EVAT law ? Explain.

a. The Constitution simply means that the initiative for filing revenue, tariff or tax bills must come from the House of Representatives on the theory that, elected as they are from the districts, the Members of the House can be expected to be more sensitive to the local needs and problems.

b. It is not the law - but the revenue bill - which is required by the Constitution to originate exclusively in the House of Representatives because a bill originating in the House may undergo such extensive changes in the Senate that the result may be a rewriting of the whole, and a distinct bill may be produced.

c. To insist that a revenue statute - not only the bill which initiated the legislative process culminating in the enactment of the law - must substantially be the same as the House bill would be to deny the Senates power not only to concur with amendments but also to propose amendment. It would be to violate the coequality of legislative power of the two houses of Congress and in fact make the House superior to the Senate.

Given the power of the Senate to propose amendments, it can propose its own version even with respect to bills which are required by the Constitution to originate in the House.

d. Nor does the Constitution prohibit the filing in the Senate of a substitute bill in anticipation of its receipt of the bill from the House, so long as action by the Senate as a body is withheld pending receipt of the House bill. (Tolentino v. Secretary of Finance and companion cases, 235 SCRA 630)

20. A petition for certiorari and/or prohibition challenging the validity of Republic Act No. 8240, amending certain provisions of the NIRC by imposing so-called "sin taxes" (actually specific taxes) on the manufacture of beer and cigarettes.

Rep. Arroyo charges that (1) in violation of Rule VIII, Sec. 35 and Rule XVII, Sec. 103 of the rules of the House of Representatives, the Chair, in submitting the conference committee report to the House, did not call for the yeas and nays, but simply asked for its approval by motion in order to prevent Rep. Arroyo from questioning the presence of a quorum; (2) in violation of Rule XIX, Sec. 112, the Chair deliberately ignored Rep. Arroyo's question, "What is that ... Mr. Speaker ?" and did not repeal Rep. Albano's motion to approve or ratify; (3) in violation of Rule XX, Secs. 121-122, Rule XXI, Sec. 123, and Rule XVIII, Sec. 109, the Chair suspended the session without first ruling on Rep. Arroyo's question which, it is alleged, is a point of order or a privileged motion. It is argued that Rep. Arroyo's query should have been resolved upon the resumption of the session on November 28, 1996, because the parliamentary situation at the time of the adjournment remained upon the resumption of the session.

On the same day, November 21, 1996, the bill was signed by the Speaker of the House of Representatives and the President of the Senate and certified by the respective secretaries of both Houses of Congress as having been formally passed by the House of Representatives and he Senate on November 21, 1996. The enrolled bill was signed into law by President Ramos on November 22, 1996.

It is now charged that the session was hastily adjourned at 3:40 p.m. on November 21, 1996 and the bill certified by Speaker de Venecia to prevent Rep. Arroyo from formally challenging the existence of a quorum and asking for a reconsideration. Rule on the controversy.

SUGGESTED ANSWER: There is no basis for the procedure being bruited as having been violated.

Under the enrolled bill doctrine, the signing of the bill by the Speaker and the Senate President and the certification by the Secretaries of both Houses are conclusive of its due enactment. (Arroyo, et al., v. de Venecia, et al., 277 SCRA 268)

21. Manila Golf & Country Club, Inc. is a non-stock corporation. It maintains a golf course and operates a clubhouse with a lounge, bar and dining room, but these facilities are for the exclusive use of its members and accompanied guests, and it charges on cost-plus-expense basis.

The club now claims that Section 42 inserting a new Section 191-A in the National Internal Revenue Code was vetoed by the President. On the other hand, the BIR maintains that Section 42 was not entirely vetoed but merely the words hotels, motels, resthouses on the ground that it might restrain the development of hotels which is essential to the tourism industry.

Rule on the conflicting contentions.

SUGGESTED ANSWER: The BIR is correct. The inclusion of hotels, motels, and resthouses are considered as items within the meaning of no. (2), Sec. 27, Art. VI of the 1987 Constitution that, the President shall have the power to veto any particular item or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to which he does not object.

In the case of Commissioner of Internal Revenue v. Court of Tax Appeals and Manila Golf & Country Club, G.R. No. 47421, May 14, 1990 it was held that hotels, motels and resthouses are considered as items which the President has the power to veto.

An item in a revenue bill does not refer to an entire section imposing a particular kind of tax, but rather to the subject of the tax and the tax rate. In the portion of a revenue bill which actually imposes a tax, a section identifies the tax and enumerates the persons liable therefore with the corresponding tax rate.

To construe the word item as referring to the whole section would tie the Presidents hand in choosing either to approve the whole section at the expense of also approving a provision therein which he deems unacceptable or veto the entire section at the expense of foregoing the collection of the kind of tax altogether.

The evil which was sought to be prevented in giving the President the power to disapprove items in a revenue bill would be perpetrated rendering that power inutile. (Commonwealth ex. rel. Elkin v. Barnett, 199 Pa. 161, 55 LRA 882 (1913)

***22. Mr. Gaerlan is the owner of a 5,000 sq. m. parcel of land located in the city limits of San Fernando City. He leased the property for P50,000.00 a year to a religious congregation for a period of fifteen (15) years (1990-2005). The religious congregation built on a 1,000 sq. m. portion a seminary and a chapel which it used in connection with its religious activities. It constructed a ten (10) story building on the remaining 4,000 sq. m. which it rented out to various commercial establishments, the proceeds of which go to the support of its various seminaries located throughout the Philippines. These seminaries are organized as non-profit and non-stock educational institutions.

Is Mr. Gaerlan exempt from the payment of real property taxes ? What about the religious congregation ? Explain. Is the religious congregation exempt from the payment of income taxes on the rental receipts ? Explain.

SUGGESTED ANSWER:

Mr. Gaerlan is exempt from the payment of real property taxes on the 1,000 sq. m. portion of his 5,000 sq. m. lot, as well as on the remaining 4,000 sq.m. On the other hand the religious congregation should pay real property taxes on the 4,000 sq. m. parcel of land and the 10-story building.

Mr. Gaerlan is exempt from real property taxation, whether on the 1,000 sq.m. or on the 4,000 sq. m. because the basis for taxation of real property is use and not ownership. The religious congregation is exempt from real property taxes on the 1,000 sq. m. parcel of land as well as on the improvements the chapel and the seminary. This is so be cause they are actually, directly and exclusively used for religious purposes. The treatment is different with regard to the 4,000 sq. m. lot and its improvement the 10 storey building. While it is true that the proceeds are used for the support of its seminaries, this is at the most indirect use, hence not subject to the tax exemption.

The religious congregation is subject to income taxation. (For reasons, refer to question no. 23, infra) While it is true that all the seminaries are organized as non-profit non-stock educational institutions, it is not their incomes which is the subject of the problem but that of the religious congregation which is not a non-profit non-stock educational institution.

***23. YMCA was established as a welfare, educational and charitable non-profit corporation earned an income of P600 thousand from leasing out a portion of its premises to small shop owners, like restaurants an canteen operators, and P44 thousand from parking fees collected from non-members. It was subjected to an assessment for non-payment of income taxes on the foregoing income.

YMCA claims that it is tax exempt claiming for the reason that the leasing to small shop owners and the operation of the parking lot are reasonably necessary for the accomplishment of its objectives. It premises its claim on the provisions of the 1987 Constitution. Is the income derived from rentals of the real property subject to income tax ? Reason out your answer.

SUGGESTED ANSWER: Yes, the income is subject to income tax. The NIRC recognizes the exemption from tax of the incomes of civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, as well as clubs organized and operated exclusively for pleasure, recreation, and other non-profitable purposes where no part of the net income inures to the benefit of any private stockholder or member.

However, the tax exemption so recognized does not flow to income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit, regardless of the disposition made of such income, which shall be subject to income taxes.

Furthermore, the constitutional tax exemptions refer only to real property that are actually, directly and exclusively used for religious, charitable or educational purposes, and that the only constitutionally recognized exemption from taxation of revenues are those earned by non-profit, non-stock educational institutions which are actually, directly and exclusively used for educational purposes. YMCA is not an educational institution embraced under this particular concept. (Commissioner of Internal Revenue v. Court of Appeals, et al., 298 SCRA 83)

***24. Asean Kiddie School, Inc., is a non-profit, non-stock educational institution. It owns a one hectare lot, one-half of which is occupied by the school campus and the other half is leased to Agri-Farms, Inc., for use as a flower garden to meet the export requirements of Agri-Farms, Inc. The rentals collected from Agri-Farms are used by Asean to pay for the salaries of its school teachers. Anticipating higher expenditures for operating the school during the school year 1997-98, the school increased its tuition fees and started collecting the increased fees as early as April 1997. The advanced collections were in the meantime deposited in a local bank where it earns interest. An international organization donated US$10,000.00 on the solitary condition that it should be used to upgrade the salaries of the school administrators. The school also wants to import some computers for the use of its students.

You are now consulted to explain the tax implications of the above and give your advice. What shall you say ?

SUGGESTED ANSWER:

a. The school is exempt from the payment of real property taxes on the one-half portion of its one hectare lot which is being used as the school campus. This is so because the same is actually, directly and exclusively used for educational purposes.

Agri-Farms is subject to the payment of real property taxes on the remaining one-half that it leases from Asean for the reason that the said portion is used for commercial purposes and not actually, directly and exclusively for educational purposes. Aseans tax exemption privilege does not flow to Agri-Farms because real property taxation is based on use and not on ownership. While it is true that the rental income is devoted to educational purposes, it has no bearing in the case as it is the land that should the actually, directly and exclusively used for educational purposes.

b. The income derived from the tuition fees is exempt from the income taxes as these are to be actually, directly and exclusively used for educational purposes being devoted to meet the increased school operational expenditures.

c. The passive income in the form of interests on bank deposits may be exempt from income taxes and the withholding taxes of 20% if they are reflected on the schools annual information returns and duly audited financial statements, supported by a certification from the depository bank as to the amount of interest income earned from passive investments not subject to the 20% final withholding tax, a resolution of the schools Board of Trustees on the proposed projects to be funded out of the money deposited in the bank, and a certification of actual utilization of said interest income for actual, direct and exclusive use for educational purposes. (Finance Department Order No. 149-95, issued November 24, 1995 amending Department Order No. 137-87 as amended by Department Order No. 92-88).

d. While it is true that the US$10,000.00 is to be utilized for administration purposes, and under Sec. 94(A-3) of the NIRC, may be subject to tax, it is to be noted that Republic Act No. 7798 which amended B.P. Blg. 232 provides that, Taxes shall not be due on donations to educational institutions. It is to be noted that exemptions to educational institutions are not subject to the so-called strictissimi juris strict interpretation against the taxpayer and liberally in favor of the government.

e. The computers could be imported, exempt from the payment of customs duties and value-added tax as there is showing of their actual, direct and exclusive use for educational purposes.

25. Why is it important to know the distinctions between a tax and a debt. What are the distinctions between a tax and a debt ?

SUGGESTED ANSWER: It is important to know the distinctions because non-payment of a tax (except a poll tax) could subject a person to imprisonment while no person could be imprisoned for non-payment of a debt. Furthermore, a debt could be compensated by another debt, but a debt or another tax could not be compensated for a tax in accordance with the lifeblood doctrine.

***Distinctions between a tax and a debt:

a. BASIS. Tax is based on law WHILE debt is based on contract or judgment.

b. FAILURE TO PAY. Failure to pay a tax (except a poll tax) may result in imprisonment WHILE there is no imprisonment for failure to pay a debt.

c. MODE OF PAYMENT. Tax is generally payable in money WHILE debt may be payable in money, property or services.

d. ASSIGNABILITY. A tax is not assignable WHILE a debt is assignable.

e. INTEREST. A tax does not draw interest unless delinquent WHILE a debt draws interest if stipulated or delayed.

f. AUTHORITY. Taxes are imposed by public authority WHILE debt can be imposed by private individuals.

g. PRESCRIPTION. Prescriptive periods for tax are determined under the NIRC WHILE debt, under the Civil Code.

26. Are there distinctions between a tax and a license fee ? Why is it important to know the distinctions ?

SUGGESTED ANSWERS: The following are the distinctions between a tax and a license fee:

a. PURPOSE:A tax is imposed for revenue purposes WHILE a license fee is imposed for regulatory purposes.

b. BASIS: A tax is imposed under the power of taxation WHILE a license fee is imposed under police power.

c. AMOUNT: There is no limit as to the amount of a tax WHILE the amount of license fee that could be collected is limited to the cost of the license and the expenses of police surveillance and regulation.

d. TIME OF PAYMENT: Taxes are normally paid after the start of a business WHILE a license fee before the commencement of business.

e. EFFECT OF NON-PAYMENT: Failure to pay a tax does not make the business illegal WHILE failure to pay a license fee makes the business illegal.

f. SURRENDER: Taxes being the lifeblood of the state, cannot be surrendered except for lawful consideration WHILE a license fee may be surrendered with or without consideration.

It is important to know the distinctions because the limitations for one may not be applied to the other except in the instance where regulatory taxes are imposed thus, the power to tax is exercised cojointly with the police power. Furthermore, exemption from taxes does not include exemption from the payment of license fees and vice-versa.

NOTES AND COMMENTS: Recall the distinctions between the power of taxation and police power with respect to: Purpose, amount, compensation, property taken, what is done with the property taken, relation to the non-impairment clause.

THE COURT OF TAX APPEALS AND TAX REMEDIES

27. What is the Court of Tax Appeals ? What is the nature of the Court of Tax Appeals ? Why was it created ?

SUGGESTED ANSWER:

a. The Court of Tax Appeals is the special tax court created under Republic Act No. 1125 composed of a Presiding Judge and Two Associate Judges, appointed by the President of the Philippines from nominees of the Judicial and Bar Council.

b. It is not a mere administrative agency or tribunal but a regular court vested with exclusive appellate jurisdiction over cases arising under the National Internal Revenue Code and the Tariff and Customs Code.

***c. The Court of Tax Appeals was created:

1) To prevent delay in the disposition of tax cases by the then Courts of

First Instance (now RTCs), in view of the backlog of civil, criminal, and cadast-

ral cases accumulating in the dockets of such courts; and

2) To have a body with special knowledge which ordinary Judges of the

then Courts of First Instance (now RTCs), are not likely to possess, thus pro-

viding for an adequate remedy for a speedy determination of tax cases.

***28. What is the jurisdiction of the Court of Tax Appeals ?

SUGGESTED ANSWER:

a. The Court of Tax Appeals has jurisdiction over decisions of the Commissioner of Internal Revenue over:

1) Cases involving:

a) Disputed assessments;

b) Refund of internal revenue taxes, fees or other charges;

c) Penalties imposed in relation thereto.

2) Other matters arising under:

a) The National Internal Revenue Code, or

b) Other law or part of law administered by the Bureau of Internal

Revenue.

The appeal to the Court of Tax Appeals must be filed within 30 days from receipt of the Commissioners adverse decision. If there is no decision, the appeal should be dismissed for lack of jurisdiction.

b. The Court of Tax Appeals has jurisdiction over decisions of the Commissioner of Customs over:

1) Cases involving:

a) Liability for customs duties, fees or other money charges,

b) Seizures, detention or release of property affected,

c) Fines, forfeitures and other penalties imposed in relation thereto;

2) Other matters arising under:

a) the customs law, or

b) Other law or part of law administered by the Bureau of Customs

The appeal to the Court of Tax Appeals must be filed within 30 days from receipt of the Commissioners adverse decision. If there is no decision, the appeal should be dismissed for lack of jurisdiction. ***c. Instances where the Court of Tax Appeals would have jurisdiction even if there is no decision yet of the Commissioner of Internal Revenue:

1) Where the Commissioner has not acted on the disputed assessment after a period of 180 days from submission of complete supporting documents, the taxpayer has a period of 30 days from the expiration of the 180 day period within which to appeal to the Court of Tax Appeals. (last par., Sec. 228 (e), NIRC of 1997)

2) Where the Commissioner has not acted on an application for refund or credit and the two year period from the time of payment is about to expire, the taxpayer has to file his appeal with the Court of Tax Appeals before the expiration of two years from the time the tax was paid.

***d. Instances where the Court of Tax Appeals would have jurisdiction even if there is no decision of the Commissioner of Customs:

1) Decisions of the Secretary of Trade and Industry or the Secretary of Agriculture in anti-dumping and countervailing duty cases are appealable to the Court of Tax Appeals within thirty (30) days from receipt of such decisions.

2) In case of automatic review by the Secretary of Finance in seizure or forfeiture cases where the value of the importation exceeds P5 million or where the decision of the Collector of Customs which fully or partially releases the shipment seized is affirmed by the Commissioner of Customs.

***29. Only Commissioners final decision denying the dispute is subject of appeal. Words to the effect that the matter would be referred to the Collection Enforcement Division for the issuance of a warrant of levy and distraint is not a final decision appealable to CTA (Solid Cement Corporation vs. Court of Tax Appeals, et al., CA-GR SP No. 33516, February 28, 1995). Even the actual issuance of a warrant of distraint and levy in certain cases still cannot be considered a final decision on a disputed assessment. (Commissioner of Internal Revenue v. Union Shipping Corp., 185 SCRA 547)

NOTES AND COMMENTS:

***a. Acts of BIR Commissioner considered as denial of protest which serve as basis for appeal to the Court of Tax Appeals:

1) Filing by the BIR of a civil suit for collection of the deficiency tax is considered a denial of the request for reconsideration. (Commissioner of Internal Revenue v. Union Shipping Corporation, 185 SCRA 547)

2) An indication to the taxpayer by the Commissioner in clear and unequivocal language of his final denial not the issuance of the warrant of distraint and levy. What is the subject of the appeal is the final decision not the warrant of distraint. Commissioner of Internal Revenue v. Union Shipping Corporation, 185 SCRA 547)

3) A BIR demand letter sent to the taxpayer after his protest of the assessment notice is considered as the final decision of the Commissioner on the protest. (Surigao Electric Co., Inc. v. Court of Tax Appeals, et al., 57 SCRA 523)

4) A letter of the BIR Commissioner reiterating to a taxpayer his previous demand to pay an assessment is considered a denial of the request for reconsideration or protest and is appealable to the Court of Tax Appeals. (Commissioner v. Ayala Securities Corporation, 70 SCRA 204)

***b. Requisites for validity of the Commissioners decision on the dispute. The decision of the Commissioner or his duly authorized representative shall (a) state the facts, the applicable law, rules and regulations, or jurisprudence on which such decision is based, otherwise, the decision shall be void, in which case the same shall not be considered a decision on the disputed assessment; and (b) that the same is his final decision. (Sec. 3.1.6, Rev. Regs. 12-99)

***30. The BIR Commissioner discovered that a taxpayer keeps no records or that whatever records kept are inadequate, or that there is strong suspicion that the taxpayer has received income from undisclosed sources, or that no return was filed or the return filed was false and fraudulent. What methods have been developed by the BIR in order to determine the income of the taxpayer which should be subject to tax ? Explain each method briefly but comprehensively.

SUGGESTED ANSWER: The following are the general methods developed by the Bureau of Internal Revenue for reconstructing a taxpayers income:

a. Percentage method. The computed amount of revenues based on the percentage computation is compared to the amount of revenues reflected on the return. The percentages used may be obtained from the taxpayer, industry publication, prior years audit results, or third parties. The comparison will provide an indication on the possibility of revenue being understated.

Among the significant ratios and trends to be analyzed are the percentage mark-up, gross profits ratio or gross margin percentage, profit margin, total assets turnover, and inventory turnover.

b. Net worth method. A method of reconstructing income which is based on the theory that if the taxpayers net worth has increased in a given year in an amount larger than his reported income, he has understated his income for that year. The net worth on a fixed starting date is compared with the net worth on a fixed ending date. Any increase in net worth is presumed to be income not declared for tax purposes.

The difficulty of establishing the opening net worth of a tax payer has led to the Cohan Rule which means the use estimates or approximations of the amount of cash and other asserts where the taxpayer lacks adequate records.

c. Bank deposit method. The bank records of the taxpayer are analyzed and the BIR estimates income on the basis of the total bank deposits after eliminating non-income items. This method stands on the premise that deposits represent taxable income unless otherwise explained as being non-taxable items. This method may be used only where the BIR has been legally allowed access to the taxpayers bank records.

d. Cash expenditure method. This method assumes that the excess of a taxpayers expenditures during the tax period over his reported income for that period is taxable to the extent not disproved otherwise.

e. Unit and value method. The determination or verification of gross receipts may be computed by applying price and profit figures to the known ascertainable quality of business of the taxpayer. For example, in order to determine the gross receipts of a pizza parlor, multiply the pounds of flour used by the number of pizzas per pound which in turn would then be multiplied by the average price per pizza.

f. Third party information or access to records method. The BIR may require third parties, public or private to supply information to the BIR.

g. Surveillance and assessment method. (Chapter XIII. Indirect Approach to Investigation, Handbook on Audit Procedures and Techniques Volume I, pp. 68-74)

***31. The BIR discovered that Elvie, a businesswoman, did not file her income tax returns for the taxable years 1998 and 1999. A pre-assessment notice for back taxes was then issued in the amount of P2 million which ultimately matured into an assessment notice. The BIR arrived at the additional tax due after using the net worth method and access to Elvies purchases from her suppliers of raw materials. She now disputes the assessment for lack of legal basis because of the use of the net worth which is not authorized under the Tax Code, and for violation of her constitutional rights when her purchase records were accessed from her suppliers. Rule on her dispute.

SUGGESTED ANSWER: Elvies contentions are bereft of merit. Since Elvie did not file her income tax returns, which reports are required by law as a basis for assessment, then the BIR Commissioner shall assess the tax on the best evidence available. The BIR Commissioner is authorized to secure records from public or private entities to assist him in the assessment. Furrthermore, the BIR may use such method as in the opinion of the Commissioner clearly reflects the income.

NOTES AND COMMENTS:

a. General Rule. The taxable income shall be computed upon the basis of the taxpayers annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be in accordance with such method as in the opinion of the Commissioner clearly reflects the income. (Sec. 43, NIRC of 1997)

b. Failure to Submit Required Returns, Statements, Reports or Other Documents.

When a report required by law as a basis for the assessment of any national internal revenue tax shall not be forthcoming within the time fixed by laws or rules and regulations or when there is reason to believe that any such report is false, incomplete or erroneous, the Commissioner shall assess the proper tax on the best evidence obtainable.

In case a person fails to file a required return or other document at the time prescribed by law, or willfully or otherwise files a false or fraudulent return or other document, the Commissioner shall make or amend the return from his own knowledge and from such information as he can obtain through testimony or otherwise, which shall be prima facie correct and sufficient for all legal purposes. [Sec. 6 (B), NIRC of 1997]

***c. Power of the Commissioner to Obtain Information. In ascertaining the correctness of any return, or in making a return when none has been made, or in determining the liability of a person for any internal revenue tax, or in collecting any such liability, or in evaluating tax compliance, the Commissioner is authorized: xxx

To obtain on a regular basis from any person other than the person whose internal revenue tax laibility is subject to audit or investigation, or from any office or officer of the national and local governments, government agencies and instrumentalities including the Bangko Sentral ng Pilipinas and government-owned or controlled corporations, any information such as, but not limited to, costs and volume of production, receipts or sales and gross incomes of taxpayers, and the names , addresses, and financial statements of corporations, mutual fund companies, insurance companies, regional operating headquarters or multinational companies, joint accounts, associations, joint ventures or consortia and registered partnerships, and their members; xxx [Sec. 5 (B), NIRC of 1997)

32. What is a pre-assessment notice and what is its importance ?

SUGGESTED ANSWER: A pre-assessment notice is a a letter sent by the Bureau of Internal Revenue to a taxpayer asking him to explain within a period of fifteen (15) days from receipt why he should not be the subject of an assessment notice.

As a general rule, the BIR could not issue an assessment notice without first issuing a pre-assessment notice because it is part of the due process rights of a taxpayer to be given notice in the form of a pre-assessment notice, and for him to explain why he should be the subject of an assessment notice.

***NOTES AND COMMENTS: Instances where a pre-assessment notice is not required before a notice of assessment is sent to the taxpayer:

a. When the finding for any deficiency tax is the result of mathematical error in the computation of the tax as appearing on the face of the return; or

b. When a discrepancy has been determined between the tax withheld and the amount actually remitted by the withholding agent; or

c. When a taxpayer opted to claim a refund or tax credit of excess creditable withholding tax for a taxable period was determined to have carried over and automatically applied the same amount claimed against the estimated tax liabilities for the taxable quarter or quarters of the succeeding table year; or

d. When the excess tax due on excisable articles has not been paid; or

e. When an article locally purchased or imported by an exempt person, such as, but not limited to vehicles, capital equipment, machineries and spare parts, has been sold, trade or transferred to non-exempt persons. (Sec. 228, NIRC of 1997)

33. On the basis of a Letter of Authority, for the examination of the books of accounts and other accounting records of Pascor Realty and Development Corporation (PRDC), BIR examiners recommended the issuance of an assessment notice in the amounts of P7 million and P 3 million for the years 1986 and 1987 respectively.

On March 1, 1995, the BIR filed a criminal complaint with the Department of Justice against PRDC, its President and Treasurer alleging evasion of taxes in the total amount of P10 million. This was supported by an affidavit-report of the examiners detailing the computation of the alleged tax evasion. PRDC, its President and Treasurer filed an Urgent Request for Reconsideration/Reinvestigation disputing the tax assessment and tax liability. On March 23, 1995, PRDC and its President and Treasurer received a subpoena in connection with the criminal complaint filed by the BIR against them.

In a letter dated May 17, 1995, the Commissioner denied the urgent request for reconsideration/reinvestigation filed by PRDC and its officers on the ground that formal assessment has as yet not been issued by the Commissioner.

Do you agree with the decision of the Commissioner ? Explain briefly.

SUGGESTED ANSWER: Yes, the affidavit-report of the examiners does not constitute an assessment that may be the subject of a motion for reconsideration/reinvestigation. The affidavit-report merely contained a computation of the liabilities. It did not state a demand or a period for payment. It was not addressed to the taxpayers but to the Department of Justice.

That the affidavit-report contained details of the tax liabilities does not ipso facto make the same an assessment. Its purpose was merely to support the criminal complaint for assessment. Clearly, it was not meant to be a notice of the tax due and a demand for the payment thereof.

The fact that the complaint itself was specifically directed and sent to the Department of Justice and not to the taxpayer shows that the intent of the BIR was to file a criminal complaint for tax evasion, not to issue an assessment. Although the revenue officers recommended the issuance of an assessment, the commissioner instead opted to file a criminal complaint. What was received by the taxpayer was notice of the filing of the criminal case not a notice that the BIR had made an assessment. (Commissioner of Internal Revenue v. Pascor Realty and Development Corporation, et al., G.R. No. 128315, prom. June 29, 1999)

NOTES AND COMMENTS: The NIRC defines the specific functions and effects of an assessment. To consider the affidavit-report attached to the criminal complaint as a proper assessment is to subvert the nature of an assessment and to set a bad precedent that will prejudice innocent taxpayers.

While an assessment informs the taxpayer that he or she has tax liabilities, not all documents coming from the BIR containing a computation of the tax liability can be deemed assessments.

To start with, an assessment must be sent to and received by a taxpayer and must demand the payment of the taxes therein within a specific period. Thus, the NIRC imposes a 25% penalty, in addition to the tax due, in case the taxpayer fails to pay the deficiency tax within the time prescribed for its payment in the notice of assessment. Likewise, an interest of 20% per annum, or such higher rate as may be prescribed by rules and regulations, is to be collected from the date prescribed for its payment until full payment.

The issuance of an assessment is vital in determining the period of limitation regarding its proper issuance and the period within which to protest it. Necessarily, the taxpayer must be certain that a specific document constitutes an assessment. Otherwise, confusion would arise regarding the period within which to make an assessment or to protest the same; or whether interest and penalty may accrue thereon.

It should also be stressed that the said document is a notice duly sent to the taxpayer. Indeed, an assessment is deemed made only when the BIR releases, mails or sends such notice to the taxpayer. Commissioner of Internal Revenue v. Pascor Realty and Development Corporation, et al., G.R. No. 128315, prom. June 29, 1999)Pascor has also defined assessment as laying a tax.

NOTES AND COMMENTS: The word assessment when used in connection with taxation, may have more than one meaning. The ultimate purpose of an assessment to such a connection is to ascertain the amount that each taxpayer is to pay. More commonly the word assessment means the official valuation of a taxpayers property for purpose of taxation. The above definition of assessment finds application under internal revenue taxation, tariff and customs taxation as well as local government taxation.

For real property taxation, there may be a special meaning to the burdens that are imposed upon real properties that have been benefited by a public works expenditure of a local government. It is sometimes called a special assessment or a special levy.

The prescriptive periods for making assessments are three (3) years from the last day within which to file a return or when the return was actually filed and ten years from discovery of the failure to file the tax return or discovery of falsity or fraud in the return.

***34. What is meant by jeopardy assessment ?

SUGGESTED ANSWER: A delinquency tax assessment which was assessed without the benefit of complete or partial audit by an authorized revenue officer, who has reason to believe that the assessment and collection of a deficiency tax will be jeopardized by delay because of the taxpayers failure to comply with the audit and investigation requirements to present his books of accounts and/or pertinent records, or to substantiate all or any of the deductions, exemptions, or credits claimed in his return. [Sec. 3.1 (a), Rev. Regs. No. 6-2000)

NOTES AND COMMENTS:

a. Jeopardy assessment is an indication of the doubtful validity of the assessment, hence it may be subject to a compromise. [Sec. 3.1 (a), Rev. REgs. No. 6-2000]

***b. Requirements for validity of formal letter of demand and assessment notice. The letter of demand calling for payment of the taxpayers deficiency tax or taxes shall state the facts, the law, rules and regulations, or jurisprudence on which the assessment is based, otherwise, the formal letter of demand and assessment notice shall be void. (Sec. 3.1.4, Rev. Regs. No. 12-99)

***35. X Corporation filed its income tax returns in January, 1995 for its income for the year 1994. In October, 1997, March, 1998 and May, 1998, X through its authorized representative signed three (3) separate waivers of the Statute of Limitations under the NIRC. The waivers were not signed by the BIR Commissioner or his agents.

In 1999, the BIR issued letters of demand, accompanied by assessment notices asking the corporation to pay the deficiency internal revenue taxes for its income for the year 1994. X disputed the assessment and requested a reinvestigation. The BIR Commissioner denied the protest. X appealed to the Court of Tax Appeals, on the ground of prescription. Decide.

SUGGESTED ANSWER: The BIRs authority to assess already prescribed. The three (3) waivers did not suspend the running of the prescriptive period.

The only agreement that could suspend the running of the prescriptive period for the collection of the tax in question is a written agreement between X corporation an the BIR entered into before the expiration of the three (3) year prescriptive period. extending the said period.

Since, what is required is the signatures of both the Commissioner and the taxpayer, a unilateral waiver on the part of the taxpayer does not suspend the prescriptive period. (Commissioner of Internal Revenue v. Court of Appeals, et al., G.R. No. 115712, February 25, 1999 (Carnation case)

NOTES AND COMMENTS: Grounds for suspending statute of limitations or prescriptive periods for assessment, beginning or distraint or levy or proceeding in court.

The holding in Commissioner of Internal Revenue v. Court of Appeals, et al., G.R. No. 115712, February 25, 1999 (Carnation case) that the waiver of the period for assessment must be in writing and have the written consent of the BIR Commissioner is still doctrinal because of the provisions of Sec. 223, NIRC of 1997 which provides:

a. When the Commissioner is prohibited from making the assessment, or beginning distraint, or levy or proceeding in court and for sixty (60) days thereafter;

b. When the taxpayer requests for and is granted a reinvestigation by the commissioner;

c. When the commissioner could not be located in the address given by him in the return filed upon which the tax is being assessed or collected;

d. When the warrant of distraint and levy is duly served upon the taxpayer, his authorized representative, or a member of his household with sufficient discretion, and no property could be located; and

e. When the taxpayer is out of the Philippines.

Law on prescription should be liberally construed in favor of the taxpayer. For the purpose of safeguarding taxpayers from an unreasonable examination, investigation or assessment, our tax law provides a statute of limitation on the collection of taxes.

Thus, the law on prescription, being a remedial measure, should be liberally construed in order to afford such protection. As a corollary, the exceptions to the law on prescription should perforce be strictly construed. (Commissioner of Internal Revenue v. B.F. Goodrich Phils., Inc., et al., G.R. No. 104171, February 24, 1999)

Requirements for validity of taxpayers protest. The taxpayer shall state the facts, the applicable law, rules and regulations, or jurisprudence on which his protest is based, otherwise, his protest shall be considered void and without force and effect. If therer are several issues involved in the disputed assessment and the taxpayer fails to state the facts, the applicable law, rules and regulations, or jurisprudence in support of his protest against some of the several issues on which the assessment is based, the same shall be considered undisputed issue or issues, in which case, the taxpayer shall be required to pay the corresponding deficiency tax or taxes attributable thereto. (Sec. 3.1.5, Rev. Regs. 12-99)

36. B.F. Goodrich availing of the Parity Amendment to the Constitution purchased various parcels of land. When the Parity Amendment expired in 1974, it sold the parcels for P500,000.00 payable in installments and leased back the properties for 25 years. It filed its 1974 return reporting the sale. A BIR assessment on its income for 1974 was paid. In 1980 it was assessed donors tax because the BIR considered the consideration for the sale insufficient, and the difference between the fair market value and the actual purchase price, a taxable donation. Subsequently, on April 9, 1981 the BIR increased the assessment.

Was there a false and fraudulent return within the context of the Tax Code which would allow assessment beyond the five year [under the present Tax Code, three (3) years ?

SUGGESTED ANSWER: No, the fact that B.F. Goodrich sold the property for a price lower than its declared fair market value did not constitute a false return which contains wrong information due to mistake, carelessness or ignorance. It is possible that real property may be sold for less than adequate consideration for a bona fide business purpose, in such event, the sale remains an arms length transaction. In the case at bar, B.F. Goodrich was trying to minimize its loss because of the expiration of the Parity Amendment. Besides, the 25 year lease was another consideration.

B.F. Goodrich declared the sale in its 1974 return submitted to the BIR Within the prescriptive period, the BIR could have made the assessment because the declared fair market value of said property was of public record.

That part of the sale transaction was actually a donation, did not erase the fact that the income had already been reported. B.F. Goodrich already reported its income by filing an income tax return. Even though a donors tax is different from capital gains tax, a tax on the gain from the sale of the taxpayers property forming part of capital assets, the tax return filed by B.F. Goodrich to report its income for the year 1974 was sufficient compliance with the legal requirement to file a return.

The BIRs oversight on the issue of prescription cannot prejudice the taxpayer. REASON: The prescriptive period was precisely intended to give the taxpayers peace of mind. (Commissioner of Internal Revenue v. B.F. Goodrich Phils., Inc., et al., G.R. No. 104171, February 24, 1999)

37. Assessment and refund cases could not be consolidated. Reason: Lifeblood doctrine. If there a pending assessment, refund should not be granted.

***38. 41 non-life insurance corporations organized and existing under the laws of the Philippines organized a pool of machinery insurers for the purpose of entering into a Quota Share Reinsurance Treaty and a Surplus Reinsurance Treaty with the Munchener Ruckversicherungs-Gesselschaft (Munich for brevity), a non-resident foreign insurance corporation.

On April 14, 1976 the pool submitted a financial statement and filed an Information Return of Organization Exempt from Income Tax for the year ending 1975, on the basis of which the pool was assessed deficiency corporate income tax of P1.8 million and withholding tax in the amount of P1.7 million and P89 thousand and to the pool on dividends paid to Munich and the pool members respectively.

The pool raises the following issues why they should not be subject to the deficiency taxes:

1. They have not formed an unregistered partnership to be treated as a corporation for tax purposes;

2. There would be double taxation if they would be made to pay the deficiency taxes; and

3. The right of the government to collect has already prescribed.

Rule on the issues raised discussing each one of them.

SUGGESTED ANSWERS:

1. They have formed an association which should be taxable like a corporation. The Tax Code has included under the term corporation partnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentas en participacion), associations, or insurance companies. [Sec. 24 now Sec. 24 (B) of the NIRC of 1997].

In Evangelista v. Collector, 102 Phil. 140, the Supreme Court already held citing Mertens that the term partnership includes a syndicate, group, pool, joint venture or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on.

There is no question that the 41 non-life corporations entered into a Pool Agreement or an association that would handle all the insurance businesses covered under their quota-share reinsurance treaty and surplus reinsurance treaty with Munich. This unmistakably indicates a partnership or an association which is considered under the Tax Code as a partnership or association treated like a corporation.

2. There is no double taxation which means taxing the same property twice when it should be taxed only once. The Pool is a taxable entity separate and distinct from the individual corporate entities of the Pool.

3. The prescriptive period was not suspended because it may be suspended only if the taxpayer informs the Commissioner of Internal Revenue of any change in the address. The fact that the Pools information return filed in 1980 indicated therein its present address is not sufficient compliance with the legal requirement.

***NOTES AND COMMENTS: The Bar examination question may be with respect to the income of an estate that has not been partitioned or to a case where there is co-ownership.

Certain business organizations do not fall under the category of corporations under the Tax Code, and therefore not subject to tax as corporations. They include:

1. General professional partnerships;

2. Joint venture or consortium formed for the purpose of undertaking construction projects engaging in petroleum, coal, geothermal, and other energy operations, pursuant to an operation or consortium agreement under a service contract with the Government. [1st sentence, Sec. 22 (B), BIRC of 1997]

39. What is a payment order ?

SUGGESTED ANSWER: A payment order contains the particular kind of tax to be paid and the corresponding TNC is issued to a taxpayer to be presented by him to the bank when he pays his taxes. (Evangelista v. People of the Philippines, et al., G.R. Nos. 108135-36, prom. September 30, 1999)

***40. Agustin died in December, 1999 leaving to his two sons, Fernando and Jose, an apartment building. After the settlement of Agustins estate, his two sons decided not to partition the apartment building and just divided the rentals among themselves for the year