Philippine Telephone & Telegraph Company v. Collector of Internal Revenue
REITERATIONFacts
The Antecedents: The Philippine Telephone & Telegraph Company (plaintiff) sought to recover income taxes paid under protest. These taxes were assessed on dividends totaling P1,014,055 distributed to foreign corporations, Philippine Islands Telephone & Telegraph Company and Telephone Investment Corporation, during the years 1927-1929. The Collector of Internal Revenue (defendant) also counterclaimed for unpaid income taxes on dividends previously paid by Philippine Islands Telephone & Telegraph Company to Philippine Telephone & Telegraph Company (P613,559.34 for 1919-1922) and by the plaintiff to Philippine Islands Telephone & Telegraph Company (P1,412,027.26 for 1923-1926). Procedural History: The plaintiff filed an action against the Collector of Internal Revenue to recover P30,421.65 in income taxes paid under protest. The Court of First Instance of Manila ruled in favor of the defendant, absolving them from the complaint and ordering the plaintiff to pay the amounts claimed in the defendant's counterclaims, totaling P57,418.41, plus legal interest. The plaintiff appealed this decision to the Supreme Court. The Petition: The plaintiff's primary argument on appeal is that it is exempt from paying income taxes on the dividends distributed to its foreign corporate stockholders due to a tax exemption and commutation clause in its franchise, Act No. 1368. This clause states that a 2% tax on gross receipts shall be in lieu of all other taxes on the franchise or earnings thereof. The plaintiff contends this exemption extends to dividends paid to its stockholders. The defendant argues that the exemption applies only to the franchise and its earnings while held by the corporation, not to dividends once they are distributed and become the property of the stockholders. The Supreme Court is asked to determine the scope of the tax exemption provided by Act No. 1368.
Issue(s)
Whether the income tax levied on dividends distributed by a domestic corporation to its foreign corporate stockholders is covered by the tax exemption granted under Section 5 of Act No. 1368. Whether dividends paid to foreign corporations are subject to income tax under Sections 9(b) and 13(f) of Act No. 2833 (Income Tax Law).
Ruling
The Supreme Court affirmed the decision of the Court of First Instance, holding that the Philippine Telephone & Telegraph Company is liable for the income taxes assessed on the dividends distributed to its foreign corporate stockholders. The Court ruled that the exemption under Section 5 of Act No. 1368 pertains only to the franchise and the earnings of the corporation directly derived from its operations under that franchise, and does not extend to dividends once they have been distributed to stockholders, as these then become the personal income of the stockholders and are subject to taxation.
Ratio Decidendi
On the issue of whether the income tax levied on dividends distributed by a domestic corporation to its foreign corporate stockholders is covered by the tax exemption under Section 5 of Act No. 1368: The Court held that the exemption provided in Section 5 of Act No. 1368 is limited to the franchise and the earnings of the corporation directly derived from its operations under that franchise. It reasoned that once dividends are declared and paid to stockholders, they cease to be the property of the corporation and become the exclusive property of the stockholders. Therefore, these distributed dividends are not considered earnings 'of the franchise' or 'earnings thereof' in the sense intended by the exemption clause. The Court emphasized that exemptions from taxation are strictly construed and cannot be extended by implication, especially when the funds have already been transferred to the stockholders and are subject to their disposition. The Court distinguished this case from Farrington vs. Tennessee, noting that the exemption in the latter was general, whereas the exemption here was specific to the franchise and its direct earnings, and that the tax in Farrington was on shares, not on distributed dividends. On the issue of whether dividends paid to foreign corporations are subject to income tax under Sections 9(b) and 13(f) of Act No. 2833 (Income Tax Law): The Court affirmed that dividends paid to foreign corporations are indeed subject to income tax. It cited Sections 9(b) and 13(f) of the Income Tax Law, which authorize and require the withholding of taxes on income paid to nonresident alien individuals and foreign corporations. The Court also referenced established legal principles and jurisprudence, including Posadas vs. Warner, Barnes & Co. and Posadas vs. Menzi, which held that dividends, whether in cash or stock, represent income to the recipients and are taxable. The Court concluded that corporate profits become income of the stockholders only when distributed as dividends, and such distributions to foreign corporations are subject to the Philippine income tax laws.
Main Doctrine
The exemption from taxes on earnings granted by a franchise applies only to the income and earnings of the franchise itself and should not be construed to include dividends paid to stockholders, as these cease to be the property of the corporation and become the property of the stockholders, thus becoming subject to income tax.