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G.R. No. 137377 December 18, 2001

COMMISSIONER OF INTERNAL REVENUE, petitioner,vs.MARUBENI CORPORATION, respondent.

PUNO, J.:

In this petition for review, the Commissioner of Internal Revenue assails the decision dated

January 15, 1999 of the Court of Appeals in CA-G.R. SP No. 42518 which affirmed the decisiondated July 29, 1996 of the Court of Tax Appeals in CTA Case No. 4109. The tax court orderedthe Commissioner of Internal Revenue to desist from collecting the 1985 deficiency income,branch profit remittance and contractor's taxes from Marubeni Corporation after finding the latterto have properly availed of the tax amnesty under Executive Orders Nos. 41 and 64, asamended.

Respondent Marubeni Corporation is a foreign corporation organized and existing under thelaws of Japan. It is engaged in general import and export trading, financing and the constructionbusiness. It is duly registered to engage in such business in the Philippines and maintains abranch office in Manila.

Sometime in November 1985, petitioner Commissioner of Internal Revenue issued a letter ofauthority to examine the books of accounts of the Manila branch office of respondent corporation

for the fiscal year ending March 1985. In the course of the examination, petitioner foundrespondent to have undeclared income from two (2) contracts in the Philippines, both of whichwere completed in 1984. One of the contracts was with the National Development Company(NDC) in connection with the construction and installation of a wharf/port complex at the LeyteIndustrial Development Estate in the municipality of Isabel, province of Leyte. The other contractwas with the Philippine Phosphate Fertilizer Corporation (Philphos) for the construction of anammonia storage complex also at the Leyte Industrial Development Estate.

On March 1, 1986, petitioner's revenue examiners recommended an assessment for deficiencyincome, branch profit remittance, contractor's and commercial broker's taxes. Respondentquestioned this assessment in a letter dated June 5, 1986.

On August 27, 1986, respondent corporation received a letter dated August 15, 1986 frompetitioner assessing respondent several deficiency taxes. The assessed deficiency internal

revenue taxes, inclusive of surcharge and interest, were as follows:

I. DEFICIENCY INCOME TAX

FY ended March 31, 1985

Undeclared gross income (Philphos and NDCconstruction projects) P967,269,811.14

Less: Cost and expenses (50%) 483,634,905.57

Net undeclared income 483,634,905.57

Income tax due thereon 169,272,217.00

Add: 50% surcharge 84,636,108.50

20% int. p.a.fr. 7-15-85 to 8-15-86 36,675,646.90

TOTAL AMOUNT DUE P290,583,972.40

II. DEFICIENCY BRANCH PROFIT REMITTANCE TAX

FY ended March 31, 1985

Undeclared gross income from Philphos and NDCconstruction projects P483,634,905.57

Less: Income tax thereon 169,272,217.00

Amount subject to Tax 314,362,688.57

Tax due thereon 47,154,403.00

Add: 50% surcharge 23,577,201.5020% int. p.a.fr. 4-26-85 to 8-15-86 12,305,360.66

TOTAL AMOUNT DUE P83,036,965.16

III. DEFICIENCY CONTRACTOR'S TAX

FY ended March 31, 1985

Undeclared gross receipts/gross income from Philphosand NDC construction projects P967,269,811.14

Contractor's tax due thereon (4%) 38,690,792.00

Add: 50% surcharge for non-declaration 19,345,396.00

20% surcharge for late payment 9,672,698.00

Sub-total 67,708,886.00Add: 20% int. p.a.fr. 4-21-85 to 8-15-86 17,854,739.46

TOTAL AMOUNT DUE P85,563,625.46

IV. DEFICIENCY COMMERCIAL BROKER'S TAX

FY ended March 31, 1985

Undeclared share from commission income(denominated as "subsidy from Home Office") P24,683,114.50

Tax due thereon 1,628,569.00

Add: 50% surcharge for non-declaration 814,284.50

20% surcharge for late payment 407,142.25

Sub-total 2,849,995.75

Add: 20% int. p.a.fr. 4-21-85 to 8-15-86 751,539.98

TOTAL AMOUNT DUE P3,600,535.68

The 50% surcharge was imposed for your cl ient's failure to report for tax purposes the aforesaidtaxable revenues while the 25% surcharge was imposed because of your client's failure to payon time the above deficiency percentage taxes.

xxx xxx xxx"1

Petitioner found that the NDC and Philphos contracts were made on a "turn-key" basis and thatthe gross income from the two projects amounted to P967,269,811.14. Each contract was for apiece of work and since the projects called for the construction and installation of facilities in the

Philippines, the entire income therefrom constituted income from Philippine sources, hence,subject to internal revenue taxes. The assessment letter further stated that the same was

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petitioner's final decision and that if respondent disagreed with it, respondent may file an appealwith the Court of Tax Appeals within thirty (30) days from receipt of the assessment.

On September 26, 1986, respondent filed two (2) petitions for review with the Court of TaxAppeals. The first petition, CTA Case No. 4109, questioned the deficiency income, branch profitremittance and contractor's tax assessments in petitioner's assessment letter. The second, CTACase No. 4110, questioned the deficiency commercial broker's assessment in the same letter.

Earlier, on August 2, 1986, Executive Order (E.O.) No. 412 declaring a one-time amnestycovering unpaid income taxes for the years 1981 to 1985 was issued. Under this E.O., ataxpayer who wished to avail of the income tax amnesty should, on or before October 31, 1986:(a) file a sworn statement declaring his net worth as of December 31, 1985; (b) file a certifiedtrue copy of his statement declaring his net worth as of December 31, 1980 on record with theBureau of Internal Revenue (BIR), or if no such record exists, file a statement of said net worthsubject to verification by the BIR; and (c) file a return and pay a tax equivalent to ten per cent(10%) of the increase in net worth from December 31, 1980 to December 31, 1985.

In accordance with the terms of E.O. No. 41, respondent filed its tax amnesty return datedOctober 30, 1986 and attached thereto its sworn statement of assets and liabilities and net worthas of Fiscal Year (FY) 1981 and FY 1986. The return was received by the BIR on November 3,1986 and respondent paid the amount of P2,891,273.00 equivalent to ten percent (10%) of itsnet worth increase between 1981 and 1986.

The period of the amnesty in E.O. No. 41 was later extended from October 31, 1986 to

December 5, 1986 by E.O. No. 54 dated November 4, 1986.

On November 17, 1986, the scope and coverage of E.O. No. 41 was expanded by ExecutiveOrder (E.O.) No. 64. In addition to the income tax amnesty granted by E.O. No. 41 for the years1981 to 1985, E.O. No. 64 3 included estate and donor's taxes under Title III and the tax onbusiness under Chapter II, Title V of the National Internal Revenue Code, also covering theyears 1981 to 1985. E.O. No. 64 further provided that the immunities and privileges under E.O.No. 41 were extended to the foregoing tax liabilities, and the period within which the taxpayercould avail of the amnesty was extended to December 15, 1986. Those taxpayers who alreadyfiled their amnesty return under E.O. No. 41, as amended, could avail themselves of thebenefits, immunities and privileges under the new E.O. by filing an amended return and payingan additional 5% on the increase in net worth to cover business, estate and donor's tax liabilities.

The period of amnesty under E.O. No. 64 was extended to January 31, 1987 by E.O No. 95

dated December 17, 1986.

On December 15, 1986, respondent filed a supplemental tax amnesty return under the benefit ofE.O. No. 64 and paid a further amount of P1,445,637.00 to the BIR equivalent to five percent(5%) of the increase of its net worth between 1981 and 1986.

On July 29, 1996, almost ten (10) years after filing of the case, the Court of Tax Appealsrendered a decision in CTA Case No. 4109. The tax court found that respondent had properlyavailed of the tax amnesty under E.O. Nos. 41 and 64 and declared the deficiency taxes subjectof said case as deemed cancelled and withdrawn. The Court of Tax Appeals disposed of asfollows:

"WHEREFORE, the respondent Commissioner of Internal Revenue is hereby

ORDERED to DESIST from collecting the 1985 deficiency taxes it had assessedagainst petitioner and the same are deemed considered [sic] CANCELLED and

WITHDRAWN by reason of the proper availment by petitioner of the amnesty underExecutive Order No. 41, as amended."4

Petitioner challenged the decision of the tax court by filing CA-G.R. SP No. 42518 with the Courtof Appeals.

On January 15, 1999, the Court of Appeals dismissed the petition and affirmed the decision ofthe Court of Tax Appeals. Hence, this recourse.

Before us, petitioner raises the following issues:

"(1) Whether or not the Court of Appeals erred in affirming the Decision of the Court ofTax Appeals which ruled that herein respondent's deficiency tax liabilities wereextinguished upon respondent's availment of tax amnesty under Executive OrdersNos. 41 and 64.

(2) Whether or not respondent is liable to pay the income, branch profit remittance,and contractor's taxes assessed by petitioner."5

The main controversy in this case lies in the interpretation of the exception to the amnestycoverage of E.O. Nos. 41 and 64. There are three (3) types of taxes involved herein incometax, branch profit remittance tax and contractor's tax. These taxes are covered by the amnestiesgranted by E.O. Nos. 41 and 64. Petitioner claims, however, that respondent is disqualified fromavailing of the said amnesties because the latter falls under the exception in Section 4 (b) ofE.O. No. 41.

Section 4 of E.O. No. 41 enumerates which taxpayers cannot avail of the amnesty grantedthereunder, viz:

"Sec. 4. Exceptions. The following taxpayers may not avail themselves of theamnesty herein granted:

a) Those falling under the provisions of Executive Order Nos. 1, 2 and 14;

b) Those with income tax cases already filed in Court as of the effectivity hereof;

c) Those with criminal cases involving violations of the income tax law already filed incourt as of the effectivity hereof;

d) Those that have withholding tax liabilities under the National Internal RevenueCode, as amended, insofar as the said liabilities are concerned;

e) Those with tax cases pending investigation by the Bureau of Internal Revenue as ofthe effectivity hereof as a result of information furnished under Section 316 of theNational Internal Revenue Code, as amended;

f) Those with pending cases involving unexplained or unlawfully acquired wealthbefore the Sandiganbayan;

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g) Those liable under Title Seven, Chapter Three (Frauds, Illegal Exactions andTransactions) and Chapter Four (Malversation of Public Funds and Property) of theRevised Penal Code, as amended."

Petitioner argues that at the time respondent filed for income tax amnesty on October 30, 1986,CTA Case No. 4109 had already been filed and was pending; before the Court of Tax Appeals.Respondent therefore fell under the exception in Section 4 (b) of E.O. No. 41.

Petitioner's claim cannot be sustained. Section 4 (b) of E.O. No. 41 is very clear andunambiguous. It excepts from income tax amnesty those taxpayers "with income tax casesalready filed in court as of the effectivity hereof." The point of reference is the date of effectivityof E.O. No. 41. The filing of income tax cases in court must have been made before and as ofthe date ofeffectivityof E.O. No. 41. Thus, for a taxpayer not to be disqualified under Section 4(b) there must have been no income tax cases filed in court against him when E.O. No. 41 tookeffect. This is regardless of when the taxpayer filed for income tax amnesty, provided of coursehe files it on or before the deadline for filing.

E.O. No. 41 took effect on August 22, 1986. CTA Case No. 4109 questioning the 1985deficiency income, branch profit remittance and contractor's tax assessments was filed byrespondent with the Court of Tax Appeals on September 26, 1986. When E.O. No. 41 becameeffective on August 22, 1986, CTA Case No. 4109 had not yet been filed in court. Respondentcorporation did not fall under the said exception in Section 4 (b), hence, respondent was notdisqualified from availing of the amnesty for income tax under E.O. No. 41.

The same ruling also applies to the deficiency branch profit remittance tax assessment. Abranch profit remittance tax is defined and imposed in Section 24 (b) (2) (ii), Title II, Chapter III ofthe National Internal Revenue Code.6 In the tax code, this tax falls under Title II on Income Tax.It is a tax on income. Respondent therefore did not fall under the exception in Section 4 (b) whenit filed for amnesty of its deficiency branch profit remittance tax assessment.

The difficulty herein is with respect to the contractor's tax assessment and respondent'savailment of the amnesty under E.O. No. 64. E.O. No. 64 expanded the coverage of E.O. No. 41by including estate and donor's taxes and tax on business. Estate and donor's taxes fall underTitle III of the Tax Code while business taxes fall under Chapter II, Title V of the same. Thecontractor's tax is provided in Section 205, Chapter II, Title V of the Tax Code; it is defined andimposed under the title on business taxes, and is therefore a tax on business.7

When E.O. No. 64 took effect on November 17, 1986, it did not provide for exceptions to the

coverage of the amnesty for business, estate and donor's taxes. Instead, Section 8 of E.O. No.64 provided that:

"Section 8. The provisions of Executive Orders Nos. 41 and 54 which are not contraryto or inconsistent with this amendatory Executive Order shall remain in full force andeffect."

By virtue of Section 8 as afore-quoted, the provisions of E.O. No. 41 not contrary to orinconsistent with the amendatory act were reenacted in E.O. No. 64. Thus, Section 4 of E.O. No.41 on the exceptions to amnesty coverage also applied to E.O. No. 64. With respect to Section 4(b) in particular, this provision excepts from tax amnesty coverage a taxpayer who has "incometax cases already filed in court as of the effectivity hereof." As to what Executive Order theexception refers to, respondent argues that because of the words "income" and "hereof," theyrefer to Executive Order No. 41.8

In view of the amendment introduced by E.O. No. 64, Section 4 (b) cannot be construed to referto E.O. No. 41 and its date of effectivity. The general rule is that an amendatory act operatesprospectively.9 While an amendment is generally construed as becoming a part of the originalact as if i t had always been contained therein,

10it may not be given a retroactive effect unless it

is so provided expressly or by necessary implication and no vested right or obligations ofcontract are thereby impaired.11

There is nothing in E.O. No. 64 that provides that it should retroact to the date of effectivity ofE.O. No. 41, the original issuance. Neither is it necessarily implied from E.O. No. 64 that it or anyof its provisions should apply retroactively. Executive Order No. 64 is a substantive amendment

of E.O. No. 41. It does not merely change provisions in E.O. No. 41. It supplements the originalact by adding other taxes not covered in the first.12 It has been held that where a statuteamending a tax law is silent as to whether it operates retroactively, the amendment will not begiven a retroactive effect so as to subject to tax past transactions not subject to tax under theoriginal act.13 In an amendatory act, every case of doubt must be resolved against its retroactiveeffect.

14

Moreover, E.O. Nos. 41 and 64 are tax amnesty issuances. A tax amnesty is a general pardonor intentional overlooking by the State of its authority to impose penalties on persons otherwiseguilty of evasion or violation of a revenue or tax law. 15 It partakes of an absolute forgiveness orwaiver by the government of its right to collect what is due it and to give tax evaders who wish torelent a chance to start with a clean slate.

16A tax amnesty, much like a tax exemption, is never

favored nor presumed in law.17 If granted, the terms of the amnesty, like that of a tax exemption,must be construed strictly against the taxpayer and liberally in favor of the taxing authority.18 Forthe right of taxation is inherent in government. The State cannot strip itself of the mos t essential

power of taxation by doubtful words. He who claims an exemption (or an amnesty) from thecommon burden must justify his claim by the clearest grant of organic or state law. It cannot beallowed to exist upon a vague implication. If a doubt arises as to the intent of the legislature, thatdoubt must be resolved in favor of the state.19

In the instant case, the vagueness in Section 4 (b) brought about by E.O. No. 64 shouldtherefore be construed strictly against the taxpayer. The term " income tax cases" should be readas to refer to estate and donor's taxes and taxes on business while the word "hereof," to E.O.No. 64. Since Executive Order No. 64 took effect on November 17, 1986, consequently, insofaras the taxes in E.O. No. 64 are concerned, the date of effectivity referred to in Section 4 (b) ofE.O. No. 41 should be November 17, 1986.

Respondent filed CTA Case No. 4109 on September 26, 1986. When E.O. No. 64 took effect onNovember 17, 1986, CTA Case No. 4109 was already filed and pending in court. By the time

respondent filed its supplementary tax amnesty return on December 15, 1986, respondentalready fell under the exception in Section 4 (b) of E.O. Nos. 41 and 64 and was disqualifiedfrom availing of the business tax amnesty granted therein.

It is respondent's other argument that assuming it did not validly avail of the amnesty under thetwo Executive Orders, it is still not liable for the deficiency contractor's tax because the incomefrom the projects came from the "Offshore Portion" of the contracts. The two contracts weredivided into two parts, i.e., the Onshore Portion and the Offshore Portion. All materials andequipment in the contract under the "Offshore Portion" were manufactured and completed inJapan, not in the Philippines, and are therefore not subject to Philippine taxes.

Before going into respondent's arguments, it is necessary to discuss the background of the twocontracts, examine their pertinent provisions and implementation.

The NDC and Philphos are two government corporations. In 1980, the NDC, as the corporateinvestment arm of the Philippine Government, established the Philphos to engage in the large-

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scale manufacture of phosphatic fertilizer for the local and foreign markets.20 The Philphos plantcomplex which was envisioned to be the largest phosphatic fertilizer operation in Asia, andamong the largest in the world, covered an area of 180 hectares within the 435-hectare LeyteIndustrial Development Estate in the municipality of Isabel, province of Leyte.

In 1982, the NDC opened for public bidding a project to construct and install a modern, reliable,efficient and integrated wharf/port complex at the Leyte Industrial Development Estate. Thewharf/port complex was intended to be one of the major facilities for the industrial plants at theLeyte Industrial Development Estate. It was to be specifically adapted to the site for the handlingof phosphate rock, bagged or bulk fertilizer products, liquid materials and other products of

Philphos, the Philippine Associated Smelting and Refining Corporation (Pasar),21

and otherindustrial plants within the Estate. The bidding was participated in by Marubeni Head Office inJapan.

Marubeni, Japan pre-qualified and on March 22, 1982, the NDC and respondent entered into anagreement entitled "Turn-Key Contract for Leyte Industrial Estate Port Development ProjectBetween National Development Company and Marubeni Corporation."22 The Port DevelopmentProject would consist of a wharf, berths, causeways, mechanical and liquids unloading andloading systems, fuel oil depot, utilities systems, storage and service buildings, offsite facilities,harbor service vessels, navigational aid system, fire-fighting system, area lighting, mobileequipment, spare parts and other related facilities. 23 The scope of the works under the contractcovered turn-key supply, which included grants of licenses and the transfer of technology andknow-how,24 and:

". . . the design and engineering, supply and delivery, construction, erection andinstallation, supervision, direction and control of testing and commissioning of theWharf-Port Complex as set forth in Annex I of this Contract, as well as thecoordination of tie-ins at boundaries and schedule of the use of a part or the whole ofthe Wharf/Port Complex through the Owner, with the design and construction of otherfacilities around the site. The scope of works shall also include any activity, work andsupply necessary for, incidental to or appropriate under present international industrialport practice, for the timely and successful implementation of the object of thisContract, whether or not expressly referred to in the abovementioned Annex I."25

The contract price for the wharf/port complex was 12,790,389,000.00 and P44,327,940.00. Inthe contract, the price in Japanese currency was broken down into two portions: (1) theJapanese Yen Portion I; (2) the Japanese Yen Portion II, while the price in Philippine currencywas referred to as the Philippine Pesos Portion. The Japanese Yen Portions I and II werefinanced in two (2) ways: (a) by yen credit loan provided by the Overseas Economic Cooperation

Fund (OECF); and (b) by supplier's credit in favor of Marubeni from the Export-Import Bank ofJapan. The OECF is a Fund under the Ministry of Finance of Japan extended by the Japanesegovernment as assistance to foreign governments to promote economic development. 26 TheOECF extended to the Philippine Government a loan of 7,560,000,000.00 for the LeyteIndustrial Estate Port Development Project and authorized the NDC to implement thesame.27 The other type of financing is an indirect type where the supplier, i.e., Marubeni,obtained a loan from the Export-Import Bank of Japan to advance payment to its sub-contractors.28

Under the financing schemes, the Japanese Yen Portions I and II and the Philippine PesosPortion were further broken down and subdivided according to the materials, equipment andservices rendered on the project. The price breakdown and the corresponding materials,equipment and services were contained in a list attached as Annex III to the contract.29

A few months after execution of the NDC contract, Philphos opened for public bidding a projectto construct and install two ammonia storage tanks in Isabel. Like the NDC contract, it was

Marubeni Head Office in Japan that participated in and won the bidding. Thus, on May 2, 1982,Philphos and respondent corporation entered into an agreement entitled "Turn-Key Contract for

Ammonia Storage Complex Between Philippine Phosphate Fertilizer Corporation and MarubeniCorporation."

30The object of the contract was to establish and place in operating condition a

modern, reliable, efficient and integrated ammonia storage complex adapted to the site for thereceipt and storage of liquid anhydrous ammonia31 and for the delivery of ammonia to anintegrated fertilizer plant adjacent to the storage complex and to vessels at the dock.32 Thestorage complex was to consist of ammonia storage tanks, refrigeration system, ship unloadingsystem, transfer pumps, ammonia heating system, fire-fighting system, area lighting, spareparts, and other related facilities.33 The scope of the works required for the completion of theammonia storage complex covered the supply, including grants of licenses and transfer of

technology and know-how,34 and:

". . . the design and engineering, supply and delivery, construction, erection andinstallation, supervision, direction and control of testing and commissioning of the

Ammonia Storage Complex as set forth in Annex I of this Contract, as well as thecoordination of tie-ins at boundaries and schedule of the use of a part or the whole ofthe Ammonia Storage Complex through the Owner with the design and construction ofother facilities at and around the Site. The scope of works shall also include anyactivity, work and supply necessary for, incidental to or appropriate under presentinternational industrial practice, for the timely and successful implementation of theobject of this Contract, whether or not expressly referred to in the abovementioned

Annex I."35

The contract price for the project was 3,255,751,000.00 and P17,406,000.00. Like the NDC

contract, the price was divided into three portions. The price in Japanese currency was brokendown into the Japanese Yen Portion I and Japanese Yen Portion II while the price in Philippinecurrency was classified as the Philippine Pesos Portion. Both Japanese Yen Portions I and IIwere financed by supplier's credit from the Export-Import Bank of Japan. The price stated in thethree portions were further broken down into the corresponding materials, equipment andservices required for the project and their individual prices. Like the NDC contract, thebreakdown in the Philphos contract is contained in a list attached to the latter as Annex III.36

The division of the price into Japanese Yen Portions I and II and the Philippine Pesos Portionunder the two contracts corresponds to the two parts into which the contracts were classified the Foreign Offshore Portion and the Philippine Onshore Portion. In both contracts, theJapanese Yen Portion I corresponds to the Foreign Offshore Portion.37 Japanese Yen Portion IIand the Philippine Pesos Portion correspond to the Philippine Onshore Portion.38

Under the Philippine Onshore Portion, respondent does not deny its liability for the contractor'stax on the income from the two projects. In fact respondent claims, which petitioner has notdenied, that the income it derived from the Onshore Portion of the two projects had beendeclared for tax purposes and the taxes thereon already paid to the Philippine government.

39It is

with regard to the gross receipts from the Foreign Offshore Portion of the two contracts that theliabilities involved in the assessments subject of this case arose. Petitioner argues that s ince thetwo agreements are turn-key,40 they call for the supply of both materials and services to theclient, they are contracts for a piece of work and are indivisible. The situs of the two projects is inthe Philippines, and the materials provided and services rendered were all done and completedwithin the territorial jurisdiction of the Philippines.41 Accordingly, respondent's entire receiptsfrom the contracts, including its receipts from the Offshore Portion, constitute income fromPhilippine sources. The total gross receipts covering both labor and materials should besubjected to contractor's tax in accordance with the ruling in Commissioner of Internal Revenuev. Engineering Equipment & Supply Co.42

A contractor's tax is imposed in the National Internal Revenue Code (NIRC) as follows:

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"Sec. 205. Contractors, proprietors or operators of dockyards, and others . Acontractor's tax of four percent of the gross receipts is hereby imposed on proprietorsor operators of the following business establishments and/or persons engaged in thebusiness of selling or rendering the following services for a fee or compensation:

(a) General engineering, general building and specialty contractors, asdefined in Republic Act No. 4566;

xxx xxx xxx

(q) Other independent contractors. The term "independent contractors"includes persons (juridical or natural) not enumerated above (but notincluding individuals subject to the occupation tax under the Local TaxCode) whose activity consists essentially of the sale of all kinds of servicesfor a fee regardless of whether or not the performance of the service callsfor the exercise or use of the physical or mental faculties of such contractorsor their employees. It does not include regional or area headquartersestablished in the Philippines by multinational corporations, including theiralien executives, and which headquarters do not earn or derive income fromthe Philippines and which act as supervisory, communications andcoordinating centers for their affiliates, subsidiaries or branches in the Asia-Pacific Region.

xxx xxx xxx43

Under the afore-quoted provision, an independent contractor is a person whose activity consistsessentially of the sale of all kinds of services for a fee, regardless of whether or not theperformance of the service calls for the exercise or use of the physical or mental faculties ofsuch contractors or their employees. The word "contractor" refers to a person who, in the pursuitof independent business, undertakes to do a specific job or piece of work for other persons,using his own means and methods without submitting himself to control as to the petty details. 44

A contractor's tax is a tax imposed upon the privilege of engaging in business.45 It is generally inthe nature of an excise tax on the exercise of a privilege of selling services or labor rather than asale on products;

46and is directly collectible from the person exercising the privilege.

47Being an

excise tax, it can be levied by the taxing authority only when the acts, privileges or business aredone or performed within the jurisdiction of said authority.48 Like property taxes, it cannot beimposed on an occupation or privilege outside the taxing district.49

In the case at bar, it is undisputed that respondent was an independent contractor under theterms of the two subject contracts. Respondent, however, argues that the work therein were notall performed in the Philippines because some of them were completed in Japan in accordancewith the provisions of the contracts.

An examination of Annex III to the two contracts reveals that the materials and equipment to bemade and the works and services to be performed by respondent are indeed classified into two.The first part, entitled "Breakdown of Japanese Yen Portion I" provides:

"Japanese Yen Portion I of the Contract Price has been subdivided according todiscrete portions of materials and equipment which will be shipped to Leyte as unitsand lots. This subdivision of price is to be used by owner to verify invoice for Progress

Payments under Article 19.2.1 of the Contract. The agreed subdivision of JapaneseYen Portion I is as follows:

xxx xxx xxx50

The subdivision of Japanese Yen Portion I covers materials and equipment while Japanese YenPortion II and the Philippine Pesos Portion enumerate other materials and equipment and theconstruction and installation work on the project. In other words, the supplies for the project arelisted under Portion I while labor and other supplies are listed under Portion II and the PhilippinePesos Portion. Mr. Takeshi Hojo, then General Manager of the Industrial Plant Section II of theIndustrial Plant Department of Marubeni Corporation in Japan who supervised theimplementation of the two projects, testified that all the machines and equipment listed underJapanese Yen Portion I in Annex III were manufactured in Japan. 51 The machines and

equipment were designed, engineered and fabricated by Japanese firms sub-contracted byMarubeni from the list of sub-contractors in the technical appendices to eachcontract.

52Marubeni sub-contracted a majority of the equipment and supplies to Kawasaki Steel

Corporation which did the design, fabrication, engineering and manufacture thereof;53 Yashima& Co. Ltd. which manufactured the mobile equipment; Bridgestone which provided the rubberfenders of the mobile equipment;

54and B.S. Japan for the supply of radio equipment.

55The

engineering and design works made by Kawasaki Steel Corporation included the lay-out of theplant facility and calculation of the design in accordance with the specifications given byrespondent.56 All sub-contractors and manufacturers are Japanese corporations and are basedin Japan and all engineering and design works were performed in that country.

57

The materials and equipment under Portion I of the NDC Port Project is primarily composed oftwo (2) sets of ship unloader and loader; several boats and mobile equipment. 58 The shipunloader unloads bags or bulk products from the ship to the port while the ship loader loadsproducts from the port to the ship. The unloader and loader are big steel structures on top of

each is a large crane and a compartment for operation of the crane. Two sets of theseequipment were completely manufactured in Japan according to the specifications of the project.

After manufacture, they were rolled on to a barge and transported to Isabel, Leyte.59 Uponreaching Isabel, the unloader and loader were rolled off the barge and pulled to the pier to thespot where they were installed.

60Their installation simply consisted of bolting them onto the

pier.61

Like the ship unloader and loader, the three tugboats and a line boat were completelymanufactured in Japan. The boats sailed to Isabel on their own power. The mobile equipment,consisting of three to four sets of tractors, cranes and dozers, trailers and forklifts, were alsomanufactured and completed in Japan. They were loaded on to a shipping vessel and unloadedat the Isabel Port. These pieces of equipment were all on wheels and self-propelled. Onceunloaded at the port, they were ready to be driven and perform what they were designed to do.62

In addition to the foregoing, there are other items listed in Japanese Yen Portion I in Annex III tothe NDC contract. These other items consist of supplies and materials for five (5) berths, two (2)roads, a causeway, a warehouse, a transit shed, an administration building and a securitybuilding. Most of the materials consist of steel sheets, steel pipes, channels and beams andother steel structures, navigational and communication as well as electrical equipment.

63

In connection with the Philphos contract, the major pieces of equipment supplied by respondentwere the ammonia storage tanks and refrigeration units. 64 The steel plates for the tank weremanufactured and cut in Japan according to drawings and specifications and then shipped toIsabel. Once there, respondent's employees put the steel plates together to form the storagetank. As to the refrigeration units, they were completed and assembled in Japan and thereaftershipped to Isabel. The units were simply installed there. 65 Annex III to the Philphos contractlists down under the Japanese Yen Portion I the materials for the ammonia storage tank,incidental equipment, piping facilities, electrical and instrumental apparatus, foundation materialand spare parts.

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All the materials and equipment transported to the Philippines were inspected and tested inJapan prior to shipment in accordance with the terms of the contracts. 66 The inspection wasmade by representatives of respondent corporation, of NDC and Philphos. NDC, in fact,contracted the services of a private consultancy firm to verify the correctness of the tests on themachines and equipment67 while Philphos sent a representative to Japan to inspect the storageequipment.68

The sub-contractors of the materials and equipment under Japanese Yen Portion I were all paidby respondent in Japan. In his deposition upon oral examination, Kenjiro Yamakawa, formerlythe Assistant General Manager and Manager of the Steel Plant Marketing Department,

Engineering & Construction Division, Kawasaki Steel Corporation, testified that the equipmentand supplies for the two projects provided by Kawasaki under Japanese Yen Portion I were paidby Marubeni in Japan. Receipts for such payments were duly issued by Kawasaki in Japaneseand English.69 Yashima & Co. Ltd. and B.S. Japan were likewise paid by Marubeni in Japan.70

Between Marubeni and the two Philippine corporations, payments for all materials andequipment under Japanese Yen Portion I were made to Marubeni by NDC and Philphos also inJapan. The NDC, through the Philippine National Bank, established letters of credit in favor ofrespondent through the Bank of Tokyo. The letters of credit were financed by letters ofcommitment issued by the OECF with the Bank of Tokyo. The Bank of Tokyo, uponrespondent's submission of pertinent documents, released the amount in the letters of credit infavor of respondent and credited the amount therein to respondent's account within the samebank.71

Clearly, the service of "design and engineering, supply and delivery, construction, erection andinstallation, supervision, direction and control of testing and commissioning, coordination. . ."72

of the two projects involved two taxing jurisdictions. These acts occurred in two countries Japan and the Philippines. While the construction and installation work were completed withinthe Philippines, the evidence is clear that some pieces of equipment and supplies werecompletely designed and engineered in Japan. The two sets of ship unloader and loader, theboats and mobile equipment for the NDC project and the ammonia storage tanks andrefrigeration units were made and completed in Japan. They were already finished productswhen shipped to the Philippines. The other construction supplies listed under the OffshorePortion such as the steel sheets, pipes and structures, electrical and instrumental apparatus,these were not finished products when shipped to the Philippines. They, however, were likewisefabricated and manufactured by the sub-contractors in Japan. All services for the design,fabrication, engineering and manufacture of the materials and equipment under Japanese YenPortion I were made and completed in Japan. These services were rendered outside the taxing

jurisdiction of the Philippines and are therefore not subject to contractor's tax.

Contrary to petitioner's claim, the case ofCommissioner of Internal Revenue v. EngineeringEquipment & Supply Co73 is not in point. In that case, the Court found that EngineeringEquipment, although an independent contractor, was not engaged in the manufacture of airconditioning units in the Philippines. Engineering Equipment designed, supplied and installedcentralized air-conditioning systems for clients who contracted its services. Engineering,however, did not manufacture all the materials for the air-conditioning system. It imported someitems for the system it designed and installed. 74 The issues in that case dealt with servicesperformed within the local taxing jurisdiction. There was no foreign element involved in thesupply of materials and services.

With the foregoing discussion, it is unnecessary to discuss the other issues raised by the parties.

IN VIEW WHEREOF, the petition is denied. The decision in CA-G.R. SP No. 42518 is affirmed.

SO ORDERED.

Davide, Jr., C .J ., Kapunan, Pardo, and Ynares-Santiago, JJ ., concur.

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G.R. No. 153793 August 29, 2006COMMISSIONER OF INTERNAL REVENUE, Petitioner,vs.JULIANE BAIER-NICKEL, as represented by Marina Q. Guzman (Attorney-in-fact) Respondent.D E C I S I O N

YNARES-SANTIAGO, J.:Petitioner Commissioner of Internal Revenue (CIR) appeals from the January 18,2002 Decision1of the Court of Appeals in CA-G.R. SP No. 59794, which granted

the tax refund of respondent Juliane Baier-Nickel and reversed the June 28,2000 Decision

2of the Court of Tax Appeals (CTA) in C.T.A. Case No. 5633.

Petitioner also assails the May 8, 2002 Resolution3of the Court of Appealsdenying its motion for reconsideration.The facts show that respondent Juliane Baier-Nickel, a non-resident Germancitizen, is the President of JUBANITEX, Inc., a domestic corporation engaged in"[m]anufacturing, marketing on wholesale only, buying or otherwise acquiring,holding, importing and exporting, selling and disposing embroidered textileproducts."

4Through JUBANITEXs General Manager, Marina Q. Guzman, the

corporation appointed and engaged the services of respondent as commissionagent. It was agreed that respondent will receive 10% sales commission on allsales actually concluded and collected through her efforts.

5

In 1995, respondent received the amount of P1,707,772.64, representing her

sales commission income from which JUBANITEX withheld the corresponding10% withholding tax amounting to P170,777.26, and remitted the same to theBureau of Internal Revenue (BIR). On October 17, 1997, respondent filed her1995 income tax return reporting a taxable income of P1,707,772.64 and a taxdue of P170,777.26.

6

On April 14, 1998, respondent filed a claim to refund the amount of P170,777.26alleged to have been mistakenly withheld and remitted by JUBANITEX to theBIR. Respondent contended that her sales commission income is not taxable inthe Philippines because the same was a compensation for her services renderedin Germany and therefore considered as income from sources outside thePhilippines.The next day, April 15, 1998, she filed a petition for review with the CTA

contending that no action was taken by the BIR on her claim for refund .

7

On June28, 2000, the CTA rendered a decision denying her claim. It held that thecommissions received by respondent were actually her remuneration in theperformance of her duties as President of JUBANITEX and not as a mere salesagent thereof. The income derived by respondent is therefore an income taxablein the Philippines because JUBANITEX is a domestic corporation.On petition with the Court of Appeals, the latter reversed the Decision of theCTA, holding that respondent received the commissions as sales agent ofJUBANITEX and not as President thereof. And since the "source" of incomemeans the activity or service that produce the income, the sales commissionreceived by respondent is not taxable in the Philippines because it arose from themarketing activities performed by respondent in Germany. The dispositive portionof the appellate courts Decision, reads:

WHEREFORE, premises considered, the assailed decision of the Court of TaxAppeals dated June 28, 2000 is hereby REVERSED and SET ASIDE and the

respondent court is hereby directed to grant petitioner a tax refund in the amountof Php 170,777.26.SO ORDERED.8Petitioner filed a motion for reconsideration but was denied.

9Hence, the instant

recourse.Petitioner maintains that the income earned by respondent is taxable in thePhilippines because the source thereof is JUBANITEX, a domestic corporationlocated in the City of Makati. It thus implied that source of income means thephysical source where the income came from. It further argued that since

respondent is the President of JUBANITEX, any remuneration she received fromsaid corporation should be construed as payment of her overall managerialservices to the company and should not be interpreted as a compensation for adistinct and separate service as a sales commission agent.Respondent, on the other hand, claims that the income she received waspayment for her marketing services. She contended that income of nonresidentaliens like her is subject to tax only if the source of the income is within thePhilippines. Source, according to respondent is the situs of the activity whichproduced the income. And since the source of her income were her marketingactivities in Germany, the income she derived from said activities is not subject toPhilippine income taxation.The issue here is whether respondents sales commission income is taxable inthe Philippines.

Pertinent portion of the National Internal Revenue Code (NIRC), states:SEC. 25. Tax on Nonresident Alien Individual.(A) Nonresident Alien Engaged in Trade or Business Within the Philippines. (1) In General. A nonresident alien individual engaged in trade or business inthe Philippines shall be subject to an income tax in the same manner as anindividual citizen and a resident alien individual, on taxable income received fromall sources within the Philippines. A nonresident alien individual who shall cometo the Philippines and stay therein for an aggregate period of more than onehundred eighty (180) days during any calendar year shall be deemed anonresident alien doing business in the Philippines, Section 22(G) of this Codenotwithstanding.x x x x

(B) Nonresident Alien Individual Not Engaged in Trade or Business Within thePhilippines. There shall be levied, collected and paid for each taxable yearupon the entire income received from all sources within the Philippines by everynonresident alien individual not engaged in trade or business within thePhilippines x x x a tax equal to twenty-five percent (25%) of such income. x x xPursuant to the foregoing provisions of the NIRC, non-resident aliens, whether ornot engaged in trade or business, are subject to Philippine income taxation ontheir income received from all sources within the Philippines. Thus, the keywordin determining the taxability of non-resident aliens is the incomes "source." Inconstruing the meaning of "source" in Section 25 of the NIRC, resort must be hadon the origin of the provision.The first Philippine income tax law enacted by the Philippine Legislature was ActNo. 2833,10which took effect on January 1, 1920.11Under Section 1 thereof,

nonresident aliens are likewise subject to tax on income "from all sources withinthe Philippine Islands," thus

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SECTION 1. (a) There shall be levied, assessed, collected, and paid annuallyupon the entire net income received in the preceding calendar year from allsources by every individual, a citizen or resident of the Philippine Islands, a tax oftwo per centum upon such income; and a like tax shall be levied, assessed,collected, and paid annually upon the entire net income received in the precedingcalendar year from all sources within the Philippine Islands by every individual, anonresident alien, including interest on bonds, notes, or other interest-bearingobligations of residents, corporate or otherwise.Act No. 2833 substantially reproduced the United States (U.S.) Revenue Law of

1916 as amended by U.S. Revenue Law of 1917.12

Being a law of Americanorigin, the authoritative decisions of the official charged with enforcing it in theU.S. have peculiar persuasive force in the Philippines.13The Internal Revenue Code of the U.S. enumerates specific types of income tobe treated as from sources within the U.S. and specifies when similar types ofincome are to be treated as from sources outside the U.S.

14Under the said

Code, compensation for labor and personal services performed in the U.S., isgenerally treated as income from U.S. sources; while compensation for saidservices performed outside the U.S., is treated as income from sources outsidethe U.S.15A similar provision is found in Section 42 of our NIRC, thus:SEC. 42. x x x(A) Gross Income From Sources Within the Philippines. x x xx x x x

(3) Services. Compensation for labor or personal services performed in thePhilippines;x x x x(C) Gross Income From Sources Without the Philippines. x x xx x x x(3) Compensation for labor or personal services performed without thePhilippines;The following discussions on sourcing of income under the Internal RevenueCode of the U.S., are instructive:The Supreme Court has said, in a definition much quoted but often debated, thatincome may be derived from three possible sources only: (1) capital and/or (2)labor; and/or (3) the sale of capital assets. While the three elements of this

attempt at definition need not be accepted as all-inclusive, they serve as usefulguides in any inquiry into whether a particular item is from "sources within theUnited States" and suggest an investigation into the nature and location of theactivities or property which produce the income.If the income is from labor the place where the labor is done should be decisive;if it is done in this country, the income should be from "sources within the UnitedStates." If the income is from capital, the place where the capital is employedshould be decisive; if it is employed in this country, the income should be from"sources within the United States." If the income is from the sale of capitalassets, the place where the sale is made should be likewise decisive.Much confusion will be avoided by regarding the term "source" in thisfundamental light. It is not a place, it is an activity or property. As such, it has asitus or location, and if that situs or location is within the United States the

resulting income is taxable to nonresident aliens and foreign corporations.

The intention of Congress in the 1916 and subsequent statutes was to discardthe 1909 and 1913 basis of taxing nonresident aliens and foreign corporationsand to make the test of taxability the "source," or situs of the activities or propertywhich produce the income. The result is that, on the one hand, nonresidentaliens and nonresident foreign corporations are prevented from deriving incomefrom the United States free from tax, and, on the other hand, there is no undueimposition of a tax when the activities do not take place in, and the propertyproducing income is not employed in, this country. Thus, if income is to be taxed,the recipient thereof must be resident within the jurisdiction, or the property or

activities out of which the income issues or is derived must be situated within thejurisdiction so that the source of the income may be said to have a situs in thiscountry.The underlying theory is that the consideration for taxation is protection of lifeand property and that the income rightly to be levied upon to defray the burdensof the United States Government is that income which is created by activities andproperty protected by this Government or obtained by persons enjoying thatprotection.

16

The important factor therefore which determines the source of income ofpersonal services is not the residence of the payor, or the place where thecontract for service is entered into, or the place of payment, but the place wherethe services were actually rendered.

17

In Alexander Howden & Co., Ltd. v. Collector of Internal Revenue,18

the Court

addressed the issue on the applicable source rule relating to reinsurancepremiums paid by a local insurance company to a foreign insurance company inrespect of risks located in the Philippines. It was held therein that the undertakingof the foreign insurance company to indemnify the local insurance company isthe activity that produced the income. Since the activity took place in thePhilippines, the income derived therefrom is taxable in our jurisdiction.Citing Mertens, The Law of Federal Income Taxation, the Court emphasized thatthe technical meaning of source of income is the property, activity or service thatproduced the same. Thus:The source of an income is the property, activity or service that produced theincome. The reinsurance premiums remitted to appellants by virtue of thereinsurance contracts, accordingly, had for their source the undertaking to

indemnify Commonwealth Insurance Co. against liability. Said undertaking is theactivity that produced the reinsurance premiums, and the same took place in thePhilippines. x x x the reinsured, the liabilities insured and the risk originallyunderwritten by Commonwealth Insurance Co., upon which the reinsurancepremiums and indemnity were based, were all situated in the Philippines. x x x19In Commissioner of Internal Revenue v. British Overseas AirwaysCorporation (BOAC),20the issue was whether BOAC, a foreign airline companywhich does not maintain any flight to and from the Philippines is liable forPhilippine income taxation in respect of sales of air tickets in the Philippines,through a general sales agent relating to the carriage of passengers and cargobetween two points both outside the Philippines. Ruling in the affirmative, theCourt applied the case of Alexander Howden & Co., Ltd. v. Collector of InternalRevenue,and reiterated the rule that the source of income is that "activity" which

produced the income. It was held that the "sale of tickets" in the Philippines is the

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"activity" that produced the income and therefore BOAC should pay income tax inthe Philippines because it undertook an income producing activity in the country.Both the petitioner and respondent cited the case ofCommissioner of InternalRevenue v. British Overseas Airways Corporation in support of their arguments,but the correct interpretation of the said case favors the theory of respondent thatit is the situs of the activity that determines whether such income is taxable in thePhilippines. The conflict between the majority and the dissenting opinion in thesaid case has nothing to do with the underlying principle of the law on sourcing ofincome. In fact, both applied the case of Alexander Howden & Co., Ltd. v.

Collector of Internal Revenue.The divergence in opinion centered on whetherthe sale of tickets in the Philippines is to be construed as the "activity" thatproduced the income, as viewed by the majority, or merely the physical source ofthe income, as ratiocinated by Justice Florentino P. Feliciano in his dissent. Themajority, through Justice Ameurfina Melencio-Herrera, asponente, interpretedthe sale of tickets as a business activity that gave rise to the income of BOAC.Petitioner cannot therefore invoke said case to support its view that source ofincome is the physical source of the money earned. If such was the interpretationof the majority, the Court would have simply stated that source of income is notthe business activity of BOAC but the place where the person or entity disbursingthe income is located or where BOAC physically received the same. But suchwas not the import of the ruling of the Court. It even explained in detailthe business activity undertaken by BOAC in the Philippines to pinpoint thetaxable activity and to justify its conclusion that BOAC is subject to Philippineincome taxation. ThusBOAC, during the periods covered by the subject assessments, maintained ageneral sales agent in the Philippines. That general sales agent, from 1959 to1971, "was engaged in (1) selling and issuing tickets; (2) breaking down thewhole trip into series of trips each trip in the series corresponding to a differentairline company; (3) receiving the fare from the whole trip; and (4) consequentlyallocating to the various airline companies on the basis of their participation in theservices rendered through the mode of interline settlement as prescribed byArticle VI of the Resolution No. 850 of the IATA Agreement." Those activitieswere in exercise of the functions which are normally incident to, and are inprogressive pursuit of, the purpose and object of its organization as aninternational air carrier. In fact, the regular sale of tickets, its main activity, is thevery lifeblood of the airline business, the generation of sales being the paramountobjective. There should be no doubt then that BOAC was "engaged in" businessin the Philippines through a local agent during the period covered by theassessments. x x x21x x x xThe source of an income is the property, activity or service that produced theincome. For the source of income to be considered as coming from thePhilippines, it is sufficient that the income is derived from activity within thePhilippines. In BOAC's case, the sale of tickets in the Philippines is the activitythat produces the income. The tickets exchanged hands here and payments forfares were also made here in Philippine currency. The situs of the source ofpayments is the Philippines. The flow of wealth proceeded from, and occurred

within, Philippine territory, enjoying the protection accorded by the Philippine

government. In consideration of such protection, the flow of wealth should sharethe burden of supporting the government.A transportation ticket is not a mere piece of paper. When issued by a commoncarrier, it constitutes the contract between the ticket-holder and the carrier. Itgives rise to the obligation of the purchaser of the ticket to pay the fare and thecorresponding obligation of the carrier to transport the passenger upon the termsand conditions set forth thereon. The ordinary ticket issued to members of thetraveling public in general embraces within its terms all the elements to constituteit a valid contract, binding upon the parties entering into the relationship.22

The Court reiterates the rule that "source of income" relates to the property,activity or service that produced the income. With respect to rendition of labor orpersonal service, as in the instant case, it is the place where the labor or servicewas performed that determines the source of the income. There is therefore nomerit in petitioners interpretation which equates source of income in labor orpersonal service with the residence of the payor or the place of payment of theincome.Having disposed of the doctrine applicable in this case, we will now determinewhether respondent was able to establish the factual circumstances showing thather income is exempt from Philippine income taxation.The decisive factual consideration here is not the capacity in which respondentreceived the income, but the sufficiency of evidence to prove that the servicesshe rendered were performed in Germany. Though not raised as an issue, the

Court is clothed with authority to address the same because the resolutionthereof will settle the vital question posed in this controversy.23The settled rule is that tax refunds are in the nature of tax exemptions and are tobe construed strictissimi jurisagainst the taxpayer.24To those therefore, whoclaim a refund rest the burden of proving that the transaction subjected to tax isactually exempt from taxation.In the instant case, the appointment letter of respondent as agent of JUBANITEXstipulated that the activity or the service which would entitle her to 10%commission income, are "sales actually concluded and collected through [her]efforts."

25What she presented as evidence to prove that she performed income

producing activities abroad, were copies of documents she allegedly faxed toJUBANITEX and bearing instructions as to the sizes of, or designs and fabrics tobe used in the finished products as well as samples of sales orders purportedlyrelayed to her by clients. However, these documents do not show whether theinstructions or orders faxed ripened into concluded or collected sales inGermany. At the very least, these pieces of evidence show that while respondentwas in Germany, she sent instructions/orders to JUBANITEX. As to whetherthese instructions/orders gave rise to consummated sales and whether thesesales were truly concluded in Germany, respondent presented no such evidence.Neither did she establish reasonable connection between the orders/instructionsfaxed and the reported monthly sales purported to have transpired in Germany.The paucity of respondents evidence was even noted by Atty. Minerva Pacheco,petitioners counsel at the hearing before the Court of Tax Appeals. She pointedout that respondent presented no contracts or orders signed by the customers inGermany to prove the sale transactions therein.26Likewise, in her Comment to

the Formal Offer of respondents evidence, she objected to the admission of thefaxed documents bearing instruction/orders marked as Exhibits "R,"27

"V," "W",

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and "X,"28

for being self serving.29

The concern raised by petitioners counsel asto the absence of substantial evidence that would constitute proof that the saletransactions for which respondent was paid commission actually transpiredoutside the Philippines, is relevant because respondent stayed in the Philippinesfor 89 days in 1995. Except for the months of July and September 1995,respondent was in the Philippines in the months of March, May, June, andAugust 1995,30the same months when she earned commission income forservices allegedly performed abroad. Furthermore, respondent presented noevidence to prove that JUBANITEX does not sell embroidered products in the

Philippines and that her appointment as commission agent is exclusively forGermany and other European markets.In sum, we find that the faxed documents presented by respondent did notconstitute substantial evidence, or that relevant evidence that a reasonable mindmight accept as adequate to support the conclusion31that it was in Germanywhere she performed the income producing service which gave rise to thereported monthly sales in the months of March and May to September of 1995.She thus failed to discharge the burden of proving that her income was fromsources outside the Philippines and exempt from the application of our incometax law. Hence, the claim for tax refund should be denied.The Court notes that in Commissioner of Internal Revenue v. Baier-Nickel,32aprevious case for refund of income withheld from respondents remunerations forservices rendered abroad, the Court in a Minute Resolution dated February 17,

2003,33sustained the ruling of the Court of Appeals that respondent is entitled torefund the sum withheld from her sales commission income for the year 1994.This ruling has no bearing in the instant controversy because the subject matterthereof is the income of respondent for the year 1994 while, the instant casedeals with her income in 1995. Otherwise, stated, res judicata has no applicationhere. Its elements are: (1) there must be a final judgment or order; (2) the courtthat rendered the judgment must have jurisdiction over the subject matter and theparties; (3) it must be a judgment on the merits; (4) there must be between thetwo cases identity of parties, of subject matter, and of causes of action. 34Theinstant case, however, did not satisfy the fourth requisite because there is noidentity as to the subject matter of the previous and present case of respondentwhich deals with income earned and activities performed for different taxableyears.WHEREFORE, the petition is GRANTED and the January 18, 2002 Decision andMay 8, 2002 Resolution of the Court of Appeals in CA-G.R. SP No. 59794,are REVERSED and SET ASIDE. The June 28, 2000 Decision of the Court ofTax Appeals in C.T.A. Case No. 5633, which denied respondents claim forrefund of income tax paid for the year 1995 is REINSTATED.SO ORDERED.

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G.R. Nos. 179045-46 August 25, 2010COMMISSIONER OF INTERNAL REVENUE, Petitioner,vs.SMART COMMUNICATION, INC., Respondent.D E C I S I O NDEL CASTILLO, J.:The right of a withholding agent to claim a refund of erroneously or illegally withheld taxescomes with the responsibility to return the same to the principal taxpayer.This Petition for Review on Certiorariunder Rule 45 of the Rules of Court seeks to set aside theDecision1dated June 28, 2007 and the Resolution2dated July 31, 2007 of the Court of Tax

Appeals (CTA) En Banc.

Factual AntecedentsRespondent Smart Communications, Inc. is a corporation organized and existing underPhilippine law. It is an enterprise duly registered with the Board of Investments.On May 25, 2001, respondent entered into three Agreements for Programming and ConsultancyServices3with Prism Transactive (M) Sdn. Bhd. (Prism), a non-resident corporation dulyorganized and existing under the laws of Malaysia. Under the agreements, Prism was to provideprogramming and consultancy services for the installation of the Service Download Manager(SDM) and the Channel Manager (CM), and for the installation and implementation of SmartMoney and Mobile Banking Service SIM Applications (SIM Applications) and Private TextPlatform (SIM Application).On June 25, 2001, Prism billed respondent in the amount of US$547,822.45, broken down asfollows:

SDM Agreement US$236,000.00

CM Agreement 296,000.00

SIM Application Agreement 15,822.45

Total US$547,822.45 4

Thinking that these payments constitute royalties, respondent withheld the amount ofUS$136,955.61 orP7,008,840.43,

5representing the 25% royalty tax under the RP-Malaysia Tax

Treaty.6On September 25, 2001, respondent filed its Monthly Remittance Return of Final Income TaxesWithheld (BIR Form No. 1601-F)7for the month of August 2001.On September 24, 2003, or within the two-year period to claim a refund, respondent filed withthe Bureau of Internal Revenue (BIR), through the International Tax Affairs Division (ITAD), anadministrative claim for refund8of the amount of P7,008,840.43.

Proceedings before the CTA Second Divis ionDue to the failure of the petitioner Commissioner of Internal Revenue (CIR) to act on the claimfor refund, respondent filed a Petition for Review9with the CTA, docketed as CTA Case No.6782 which was raffled to its Second Division.In its Petition for Review, respondent claimed that it is entitled to a refund because the paymentsmade to Prism are not royalties10but "business profits,"11pursuant to the definition of royaltiesunder the RP-Malaysia Tax Treaty,12and in view of the pertinent Commentaries of theOrganization for Economic Cooperation and Development (OECD) Committee on Fiscal Affairsthrough the Technical Advisory Group on Treaty Characterization of Electronic CommercePayments.13Respondent further averred that since under Article 7 of the RP-Malaysia TaxTreaty, "business profits" are taxable in the Philippines "only if attributable to a permanentestablishment in the Philippines, the payments made to Prism, a Malaysian company with nopermanent establishment in the Philippines,"14should not be taxed.15On December 1, 2003, petitioner filed his Answer16arguing that respondent, as withholdingagent, is not a party-in-interest to file the claim for refund,17and that assuming for the sake of

argument that it is the proper party, there is no showing that the payments made to Prismconstitute "business profits."

18

Ruling of the CTA Second DivisionIn a Decision19dated February 23, 2006, the Second Division of the CTA upheld respondentsright, as a withholding agent, to file the claim for refund citing the cases ofCommissioner ofInternal Revenue v. Wander Philippines, Inc.,

20Commissioner of Internal Revenue v. Procter &

Gamble Philippine Manufacturing Corporation21

and Commissioner of Internal Revenue v. TheCourt of Tax Appeals.

22However, as to the claim for refund, the Second Division found respondent entitled only to apartial refund. Although it agreed with respondent that the payments for the CM and SIM

Application Agreements are "business profits,"23and therefore, not subject to tax24under the RP-Malaysia Tax Treaty, the Second Division found the payment for the SDM Agreement a royaltysubject to withholding tax.

25Accordingly, respondent was granted refund in the amount

of P3,989,456.43, computed as follows:26

Particulars Amount (in US$)

1. CM 296,000.00

2. SIM Application 15,822.45

Total US$311,822.45

Particulars Amount

Tax Base US$311,822.45

Multiply by: Withholding Tax Rate 25%

Final Withholding Tax US$ 77,955.61

Multiply by: Prevailing Exchange Rate 51.176

Tax Refund Due P3,989,456.43

The dispositive portion of the Decision of the CTA Second Division reads:WHEREFORE, premises considered, the instant petition is partially GRANTED. Accordingly,respondent Commissioner of Internal Revenue is hereby ORDERED to REFUND or ISSUE aTAX CREDIT CERTIFICATE to petitioner Smart Communications, Inc. in the amount ofP3,989,456.43, representing overpaid final withholding taxes for the month of August 2001.SO ORDERED.27Both parties moved for partial reconsideration28but the CTA Second Division denied the motionsin a Resolution29dated July 18, 2006.Ruling of the CTA En Banc

Unsatisfied, both parties appealed to the CTA En Bancby filing their respective Petitions forReview,

30which were consolidated per Resolution

31dated February 8, 2007.

On June 28, 2007, the CTA En Bancrendered a Decision affirming the partial refund granted torespondent. In sustaining respondents right to file the claim for refund, the CTA En Bancsaidthat although respondent "and Prism are unrelated entities, such circumstance does not affectthe status of [respondent] as a party-in-interest [as its legal interest] is based on its direct andindependent liability under the withholding tax system."32The CTA En Bancalso concurred withthe Second Divisions characterization of the payments made to Prism, specifically that thepayments for the CM and SIM Application Agreements constitute "business profits,"33while thepayment for the SDM Agreement is a royalty.

34

The dispositive portion of the CTA En Banc Decision reads:WHEREFORE, the instant petition is hereby DISMISSED. Accordingly, the assailed Decisionand Resolution are hereby AFFIRMED.SO ORDERED.35Only petitioner sought reconsideration36of the Decision. The CTA En Banc, however, found no

cogent reason to reverse its Decision,and thus, denied petitioners motion for reconsideration ina Resolution

37dated July 31, 2007.

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