Revenue v. Visayan Electric Company

SANCHEZ, J.:

The problems cast in legal setting in this petition for review1 of the judgment of the Court of Tax Appeals are: Is Visayan Electric Company liable for deficiency income tax on dividends from the stock investment of its employees' reserve fund for pensions? Is it also liable for 25% surcharge on alleged late payment of franchise tax? Respondent company is the holder of a legislative franchise, Act 3499 of the Philippine Legislature, to operate and maintain an electric light, heat, and power system in the City of Cebu, certain municipalities in the Province of Cebu, and other surrounding places.

In a board of directors' meeting held on March 14, 1949, respondent company established a pension fund, known as the "Employees' Reserve for Pensions." Said fund is for the benefit of its "present and future" employees, in the event of retirement, accident or disability.

Every month thereafter an amount has been set aside for this purpose. It is taken from the gross operating receipts of the company. This reserve fund was later invested by the company in stocks of San Miguel Brewery, Inc., for which dividends have been regularly received.

But these dividends were not declared for tax purposes. It was in a letter dated August 9, 1957 that the Auditor General gave notice that as the company has retained full control of the fund, therefore, the dividends are not tax exempt; but that such dividends may be excluded from gross receipts for franchise tax purposes, provided the same are declared for income tax purposes. In pursuance of the above letter, the Provincial Auditor of Cebu allowed the company the option to declare the dividends either as part of the company's income for income tax purposes or as part of its income for franchise tax purposes.

The company elected the latter.2 The Revenue Examiner of Cebu, however, conducted a separate investigation for the Bureau of Internal Revenue. His report dated September 17, 1959 likewise revealed that the "company itself is the custodian or has the complete control of the fund." That report disagreed with the action of the Provincial Auditor, instead considered the dividends as subject to corporate income tax under Section 24 of the National Internal Revenue Code.

Said report further disclosed that: (a) during the years 1957, 1958 and 1959, some payments of the franchise tax were made after fifteen days - although within twenty days - of the month following the end of each calendar quarter, allegedly contrary to Section 259 of the Tax Code, which imposes a 25% surcharge if the franchise faxes "remain unpaid for fifteen days from and after the date on which they must be paid"; and (b) from 1954 to 1959, the company had not paid additional residence tax imposed by Section 2 of Act 465. With the foregoing report as basis, the Commissioner of Internal Revenue, in two letters of demand dated September 7 and 15, 1960, assessed the following amounts against the company: (a) P2,443.30 representing deficiency income tax for the years 1953 to 1958, plus interest and 50% surcharge; (b) P3,850.00 as additional residence tax from 1954 to 1959; and (c) P35,419.05 as 25% surcharge for late payment of franchise taxes for the years 1957, 1958 and 1959.

Reconsideration having been denied, the company went to the Court of Tax Appeals on petition for review. On January 31, 1964, the Court of Tax Appeals sustained the correctness of the additional residence tax assessments3 but freed the company from liability for deficiency income tax and the 25% surcharge for late payment of franchise taxes. It is now the turn of the Commissioner of Internal Revenue to appeal to this Court.

1.

Admittedly, the investment of the fund in shares of stocks of the San Miguel Brewery, Inc. is not a part of respondent company's business. Neither is it necessary or incidental to its operation under its franchise. And yet those dividends were assessed by petitioner as part of the income of respondent company.

The tax court joins petitioner in this, but applied the following provision in Section 8, Act 3499 - the company's legislative franchise - in holding that the dividends are not subject to income tax, viz.: SEC. 8. The grantee shall pay the same taxes as are now or may hereafter be required by law from other persons, on its real estate, buildings, plant, machinery, and other personal property, except property declared exempt in this section.

In consideration of the franchise and rights hereby granted, the grantee shall pay into the municipal treasury of each municipality in which it is supplying electricity to the public under this franchise, a tax equal to two per centum of the gross earnings for electric current sold under this franchise in each of the respective municipalities.Said percentage shall be due and payable quarterly and shall be in lieu of all taxes of any kind levied, established or collected by any authority whatsoever, now or in the future , on its poles, wires, insulators, switches, transformers and other structures, installations, conductors and accessories, placed in and over the public streets, avenues, roads, thoroughfares, squares, bridges, and other places and on its franchises, rights, privileges, receipts, revenues and profits, from which taxes the grantee is hereby expressly exempted.4 We perceive incorrectness of this approach by the Tax Court.

What is envisioned in the statute granting exemption, so far as is pertinent to this case, is the last underscored portion thereof which speaks of its receipts, revenues and profits, "from which taxes the grantee is hereby expressly exempted." The heavy accent is on the word its. Plain import of this word, taken in context, is that the receipts, revenues and profits, which could be tax-exempt under the statute, must be the company's - not somebody else's.

No doubt this provision should not be broadened so as to include situations which by fail intendment are excluded therefrom. To do so is to take too loose a view of the statute. The disputed income are not receipts, revenues or profits of the company.

They do not go to the general fund of the company. They are dividends from the San Miguel Brewery, Inc. investment which form part of and are added to the reserve pension fund which is solely for the benefit of the employees,5 "to be distributed among the employees."6 Not escaping notice is that by the resolution of respondent company's board and the setting aside of monthly amounts from its gross operating receipts for that fund, said company was merely acting, with respect to such fund, as trustee for its employees. For, indeed, the intention to establish a trust in favor of the employees is clear.

A valid express trust has thus been created.7 And, for tax purposes, the employees' reserve fund is a separate taxable entity.8 Respondent company then, while retaining legal title and custody9 over the property, holds it in trust for the beneficiaries mentioned in the resolution creating the trust, in the absence of any condition therein which would, in effect, destroy the intention to create a trust.10 Given the fact that the dividends are returns of the trust estate and not of the grantor company, we must say that petitioner misconceived the import of the law when he assessed said dividends as part of the income of the company. Similarly, the tax court should not have considered them at all as the company's "receipts, revenues and profits" which are exempt from income tax.

2.

As we look back at the resolution creating the employees' reserve fund and having in mind the company's admission that it is "solely for the benefit of the employees" and that the company is holding said fund "merely as trustee of its employees,"11 we reach the conclusion that the fund may not be diverted for other purposes, and that the trust so created is irrevocable. For, really nothing in respondent company's acts suggests that it reserved the power to revoke that fund or for that matter appropriate it for itself.

The trust binds the company to its employees. The trust created is not therefore a revocable trust a provided in Section 59 of the Tax Code.12 Nor is it a trust contemplated in Section 60, the income from which is for the benefit of the grantor.13 This state of facts calls for inquiry into the applicability of Section 56 of the Tax Code, which in part reads: SEC. 56.

Imposition of tax - (a) Application of tax. - The taxes imposed by this Title upon individuals shall apply to the income of estate or of any kind of property held in trust , including - (1) Income accumulated in trust for the benefit of unborn or unascertained person or persons with contingent interests and income accumulated or held for future distribution under the terms of the will or trust; x x x x x x x x x (c) Computation and payment - (1) In general. - The tax shall be computed upon the net income of the estate or trust and shall be paid by the fiduciary , except as provided in Section fifty-nine (relating to revocable trust) and section sixty (relating to income for the benefit of the grantor); x x x x x x x x x14 Of interest here is that an amendment to Section 56 - Republic Act 1983,15 approved on June 22, 1957 - singles out employees' trust for tax exemption in the following language: (b) Exception.

- The tax imposed by this Title shall not apply to employees' trust which forms part of a pension, stock bonus or profit-sharing plan of an employer for the benefit of some or all of his employees (1) if contributions are made to the trust by such employer, or employees, or both for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan , and (2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other then for the exclusive benefit of his employees: Provided , That any amount actually distributed to any employee or distributee shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distributee.16 A dig into the legislative history unearths the fact that this exemption in Republic Act 1983 was conceived in order to encourage the formation of pension trust systems for the benefit of laborers and employees outside the Social Security Act.17 Understandably, the second requirement in paragraph (b) of Section 56 of the Tax Code as it was inserted by Republic Act 1983 - non-diversion of fund - was written into the statute the better to insure that the trust fund and its income will be used "for the exclusive benefit"

of the employees. Of importance is the employment of the word plan as it is applied to pension set forth in the first part of paragraph (b) aforesaid. Worth mentioning is that a sizeable portion of our Tax Code has been lifted from the United States Internal Revenue Code.

To be sure, Republic Act 1983 which amends Section 56 of our Tax Code is substantially similar in terms to Section 165 of the United States Internal Revenue Code of 1939.18 It is thus permissible for this Court to look into the interpretations of the American counterpart in an effort to determine the congressional scheme in exempting employees' trust from taxation.

In the American jurisdiction, the word plan is emphasized. To qualify for exemption, the employees' trust must refer to a definite program, scheme or plan. It must be set up in good faith.

It must be acturially sound. Under such plan, employees generally are to be extended retirement and pension benefits. But why?

The fund is not thereafter to be controlled or used for the benefit of the company in any way.19 A trust device used to disguise added compensation to the shareholders and officers of a company - and thereby avoid present payment of income tax thereon - instead of providing for future security of the employees in general will not qualify under the exemption.20 Hubbell vs. Commissioner of Internal Revenue, 150 F. 2d 516, 161 A.L.R. 764, 773, which was decided under the 1939 version, confirms this view. There, the United States Circuit Court of Appeals took into account the direction of the amendments in construing congressional purpose, and held that the 1942 amendment which added the requirement of non-discrimination in favor of shareholders, officials, or highly-compensated employees presents no apparent change in congressional purpose: "to insure that ... pension ...

plans are operated for the welfare of employees in general, and to prevent the trust device from being used for the benefit of shareholders, officials, or highly paid employees...." This is not to say, of course, that the employees' trust fund established by private respondent is a device calculated to unserve its purpose and serve tax evasion. Unquestionably, the trust fund was created in good faith.

It is meant as it was intended to mean - for the employees' welfare. But wanting are sufficient data which would justify this Court to make a conclusive statement that the trust qualifies under Section 56 (b) as it was inserted into the Tax Code by Republic Act 1963. The only written evidence of record of the creation of the pension trust is the minutes of the board of directors' meeting of March 14, 1949, the pertinent portion of which reads: 3.

Upon motion duly seconded, the following resolution was unanimously passed: RESOLVED, that the sum of FOUR HUNDRED FIFTEEN THOUSAND PESOS (P415,000.00) be appropriated from the surplus of the company arising from prewar operations in order to cover the payments of backpay and payment of reasonable compensations to those persons who have materially aided the Company in its Organization and Rehabilitation and in the preparation and prosecution of the Company's claims. This appropriation shall cover a reserve fund for pensions for all the present and future employees of the firm in the amount of SIXTY THOUSAND PESOS (P60,000.00), Reserve Fund for Employees' Welfare to the amount of FIFTY THOUSAND PESOS (P50,000.00). Reserve Funds for Medical Hospitalization, etc.

to the amount of THIRTY THOUSAND PESOS (P30,000.00). Reserve Fund for Insurance and Accident to the amount of TWENTY FOUR THOUSAND PESOS (P24,000.00) and a Reserve Fund for Bonuses Payable to the amount of FIFTY THOUSAND PESOS (P50,000.00). 4.

Upon motion by Mr. Jesus Moraza, duly seconded by Mr. Juan Coromina, it was resolved further that the committee consisting of Dr. Mamerto Escano, as Chairman and Messrs. Gil Garcia and Salvador E. Sala as members be constituted, as it is hereby constituted, to study the details of all the above resolutions and give effect thereto. The said committee is hereby empowered to immediately put into effect the above resolutions.

We have the admitted fact also that every month thereafter an amount has been set aside for the fund and the investment thereof in stocks of San Miguel Brewery, Inc. And yet, something is amiss. For one, there is the admission made on page 3 of respondents' brief that: ...

It is, of course, admitted by the respondent Company that the strict requirements of Section 56 (b) of the Tax Code on the formation of employees' trust funds for pension had not been strictly complied with, although said funds and their returns are exclusively for the benefit of respondent Company's employees. And then, nothing extant in the record will show a pension plan actuarially sound. Correctly did the Court of Tax Appeals find that "[i]t does not appear, however, that said pension trust was created in accordance with the provision of Section 56 (b) of the Revenue Code."21 The absence of such plan prevents us from taking a view which fits the purpose of the statute.

Coming into play then is the specific provision in paragraph (a), Section 56, heretofore transcribed, which directs that the "taxes imposed by this Title upon individuals shall apply to the income ... of any kind of property held in trust." For which reason, the income received by the employees' trust fund from January 1, 1957 is subject to the income tax prescribed for individuals under Section 21 of the Tax Code.

To follow a different construction would run "smack against the familiar rules that exemption from taxation is not favored,22 and that exemptions in tax statutes are never presumed,"23 and these "are but statements in adherence to the ancient rule that exemptions from taxation are construed in strictissimi juris against the taxpayer and liberally in favor of the taxing authority."24 3. Having reached the conclusion that the assessment made by petitioner and the ruling of the Court of Tax Appeals on lack of income tax liability were on a mistaken premise, but that the trust established by respondent should pay the taxes imposed upon individuals, we are now faced with the mechanics of tax collection. The problem of prescription comes in.

By Section 331 of the Tax Code, internal revenue taxes shall be assessed within five years after the return is filed. Here, no return was filed upon a belief in good faith that no tax liability attaches. Add to this the fact that the Commissioner of Internal Revenue made an assessment of income tax but upon the mistaken assumption that the tax payable was upon the basis of a corporate tax and not individual tax, and the picture is complete.

Good faith in one, and honest mistake in the other. Both petitioner and respondent company are on the same footing. It is because of this that we rule that Section 332 (a) of the Tax Code finds application.

It reads: SEC. 332. Exceptions as to period of limitation of assessment and collection of taxes.

- (a) In the case of a false or fraudulent return with intent to evade tax or of a failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within ten years after the discovery of the falsity, fraud, or omission. Assessment should have as starting point the known figures. From 1953 to 1958, the following amounts were dividends received on the San Miguel Brewery, Inc. investment: 1953 ...................................

P4,430.00 1954 ................................... 4,384.00 1955 ................................... 6,240.00 1956 ...................................

8,000.00 1957 ................................... 8,009.60 1958 ................................... 7,999.20 As far as we could read from the record, on the 1953 to 1956 dividends, payments under protest were made as follows: 1.

Deficiency franchise tax .................................. P468.14 2. 25% surcharge ..................................................

117.04 3. Compromise penalty ........................................ 50.00 Total ............................................