CTA Case No. 2013 (Decision)

REPU LTC OF THE PHILIPPi ~' ES COURT OF TAX APPEALS QUEZON CITY PORFI.RIO V. AS C.t:\LON, C. T. J, . CASE No. 2013 Petitioner, - versus - COHMISS IONER OF Il TERHAL REVENUE, Respondent . x- - - - - - - - - - -x DECI S IO N Petitioner has appealed from the decision of the respondent Commissioner of Internal Revenue assessing against and demanding from him payment of ~65 , 663 . 35, representing 1964 deficiency income tax,- inclusive of i~% monthly interest from .t� pril 20 , 1965 to August 30 , 1966. . Sometime in Narch , 1964, petitioner organized and formed Pandar Enterprises , Inc ., a family and closed corporation; , vrith an authorized capital of ill , ooo , ooo. 00 d iVided into 10 , 000 s h ares of PlOO. 00 per share . Their incorporators were petitioner Porfirio v. Ascalon; his vJife , .Amparo C� .Ascalon ; daughter, ]i,[!a Eva .i\scalon de Jison; son-in-l m...r , Dominador Jison, Jr.; and a r el a tive , Carlos R. J\scalon. liE shown by the a rticles of inco_rporation of Pandar Enterprises, Inc., petitioner and his wife subscribed to almost nine- tenth (9/10) of the capita l sto ck of said corporation. The amounts of t heir subscriptions; paid - up subscriptions,

D.ECLS ION - CTA c~~E No. 2013 2 and ~npaid subscriptions are itemized as follows: Amount Psid- up Uppai~ Sub�cribeQ. Sub�cription Subs cript1Qn Porfirio V. Ascalon i~9o , ooo. oo jf22, 500. 00 89 , 900. 00 22,475. 00 Amparo C. Ascalon 10 , 000. 00 2, 500. 00 Ana Eva A. Jison 2 , 500 ~ 00 Dominador Jison , Jr. 10 , 000. 00 100, 00 t_5o;oo2o2.. o0o0 Carlos R. .As calon f.2901 000.00 !i5o ,ooo....QQ. On June 22 , 1964, petitioner as lessor entered into a contract of "Lease , Acquisition of Rights and Expenses with Assumption of Obliga tions and I ncome 11 vlith the Pan- dar Enterprises , Inc. (Exh. 6, pp. 23 - 27 , BIR records . ) The lease was for a period of five (5) agricultural crop years , fro m 1963 -1964 to 1967- 68 , inclusive , for agricul- tural lands , improvements, and equipments ; and five (5) calendar years , from 1964 to 1968 , inclusive , for urban and othe r real estate properties i.vith a total book value of 602 , 293 . 92. The annual rental for the lease was i':30 , 000. 00 plus the amount of annual depr e ciation of all depreciable properties , improvements and equipment (Exh. 6 , pp . 23 - 27 , BIR records) . The lease contract proVides, among othe rs , as follm.vs: 11 Tha t in View of the fact t ha t t he L ~..sso.. has unpa i d subscriptions to shares of stock of the LESSEE corporation stand - ing :ihthe name of Porfirio V. Ascalon

DECISION - CTA C~E No. 2013 3 and Amparo c. As cal on in the total sum of One Hw1dred Thirty Four Thousand Nine Hundred 1wenty Five Pesos as follows: Unpaid Subs crip t,ion Porfirio V. Ascalon Arnparo c. As cal on Total 'Qart of the advan ced rentals r�ferr53..c1.. tQ above s.hg,ll be applied to th~ �aid unpai.d subscri_pt),ons anct the_ �arne shall then b� fully pa;it!, in which case the LESSEE shall issue in favor of the LESS01:t the corre - sponding subscription to its shares of stock as fully paid shares. 11 That the balance in th~ sl.lJ.n of Fifte~l:l 1'housang Sevepty Ji'j,ve Pesos shall be ~ this L7 SE1~ to t_he_J.,ESSO.."l upon the S;;i,gning of th~ lease contr~ct. -'1 t the LESSEE ,shall for all pur oses immediatelY take over t e operat~on o e ~ropert�ies herein leaseg . x x x ." Exh. 6 , ~P � 23 - 27, BIR rec . ; Underlining s uppl ied. ) In August , 1965, respondent caused the investigation of petitioner ' s 1964 income tax return. Subsequently, Revenue Examiner Noel C. Contreras recommended that a deficiency income tax of ~62 , 528. 21 be assessed against petitioner Porfirio V. Ascalon because the advance rent- al of' i'-120, 000. 00 corres pending to the crop years 196l.J-- 1965, 1965-1966, 1966- 1967 and 1967- 1968 at the rate of r-30 ,000.00 per annum mentioned in the lease contract should be considered as j_ncome taxable to petitioner- lessor in 1964. Out of the �150 , 000. 00 rental income allegedly paid in advance by the lessee , petitioner

DECISION CT �~ CASE No . 2013 4 declared in his i964 income tax return an income of i:30 , 000. oo , leaving ~'120 , 000, 00 as deferred inc.Qme under the liabilities section of his balance sheet attached to t he said return. (Exh. 1 - B, p . 15, BI R rec . ) The said amount of ['�120 , 000. 00 was likew ise reported and credited by the lessee , Panda r Enterprises , D1c . , in its income tax return for 1961-r as "Prepaid Rent 11 under the assets section of the balance sheet. (Exh. 11 , p. 227 , CTA rec . ) For all the years subsequent to 1964, peti- tioner reported !1"130 , 000. 00 as yearly re nt al income in his income t ax returns and paid the income t ax due there- on. The books of accounts of both "Qetitioner - lessor and lessee corporation are ke"Qt under the accrual. bas i,s . On no vember 2 , 1965 , the BIR Regional Dir e ctor at Bacolod City sent a preliminary five - day letter adv:Lsing petitioner of t he examiner ' s findings and recor.menda- tions . On August 30 , 1966 , respondent assessed against and demanded from petitioner payment of �6 5., 663 . 35 as 1964 deficiency income tax , inclusive of interest. ~rhe deficiency t ax was arrived at by adding the ret1tal in- come of ~120 , 000. 00 to petitioner ' s 1964 net income of �56 , 13 2. 21 . Petitioner protested t he assess ment in his various letters to respondent . The protest was premised on the grounds that (1) petitioner did not receive 120, 000. 00 as advance rental in 1964; (2) lessee corporation coLlid \ I

DECISION - CTA CASE No. 2013 5 not possibly have paid �120 , 000. 00 to petitioner- lessor considering the meager financial resources of the lessee corporation in 1964; (3) petitioner and his wife could not have possibly paid for their unpaid subs criptions of , 134, 925. 00 in 1964 because of their financial in - capacity to do so; (4) no receipt was issued to peti- tioner-lessor or his: wife for 134, 925. 00 corresponding� to their unpaid subscriptions; (5) no certifica tes of stock were issued by Pandar Enterprises , Inc. to peti- tioner and his wi:fe; (6) upon lessee 1s failure to advance ~150 , ooo. oc to herein petitioner , both lessor and lessee executed a supplementary lease contract to s how the real intentions of the parties in t he original contract of lease; and (7) t he books and records of � both petitioner and lessee-corpqration were adjusted to reflect parties ' intention with respect to t he advance rental of ~150 , 000. 00 . On November 28 , 1968 , res pondent denied petitioner ' s protest and ruled tha t the a vance rental of 150 , 000. 00 forms part of petitioner ' s 1964 t axable income . Hence , t his appeal. The issues posed for resolution are t he foll owing : (1) i,<Jhether or not Panclar Enterprises, Inc. has the financial c~ability to advance the rental of ~150 , 000. 00 to petitioner in 19 6~ ; (2) \fuether or not the rental of itl50 , 000. 00 found in the lease co.n - ~ract and allegedly advanced by

'I' DECISION - CTA CASE No . 2013 6 Pandar Enterprises, Inc. to petitioner constitutes taxable income of the latter in 1964; and (3) r,l/hether or not the right of the Government to assess petitioner ' s 1964 in.- come tax has prescribed . First and Second Issues: The first and second issues being interrelated , we will discuss them jointly. Petitioner contends that the lessee- corporation was not in a posit ion to pay an advance rental of �150 �, 000. 00 to petitioner in 1964 because at that time the corpora- tion has a paid- up capital of only ~5o,ooo. oo . Respondent, however , argues that the "financial capabUity 11 of lessee- corporation cannot in any way affect the validity and efficacy of the lease contract because under the terms thereof only ~15 , 075. 00 shall be paid by the lessee - corporation to petitioner upon signing of the contract. ~ The question of whether or not the lessee - corporation was in a financial positio~ in 1964 to pay in cash the amount of ~150 , 000. 00 as advance rental should be answered in the negative because at that time it has only a paid- up capital of 5o,ooo. oo. But the lessee- corporation is not required by the lessor to pay in cold cash the advance rental of ~150 , 000. 00 . vJhat was to be used by the lessee for the payment thereof was the par value of the unpaid shares of stock of the lessor in the lessee

DECISION CTA Ci-ISE No . 2013 corporation which d oes not involve any cash paym~nt . It would appear , ther,3fore , that the ovmersh ip of the corporate� shares of stock valued at ~150 , 000. 00 was acquired by the lessor after the perfection of the c ontract in 19 6~. Section 29 of the Na tio nal Internal Revenue Code defines "gross income" as including "income derived from any source whatever . 11 As the par vaJ.u3 of the corporate shares -of stock to be paid t o the lessor unde r the lease contrac t is meas urable in terms of money , it may be said t ha t t he advance re ntal of ~150 , 000. 00 was paid to the lessor - petitioner in � 19 6~. Under the facts obtain- ing in this case ' the followino accounting entries may be made , to vTi t: PORFIB.IO V. CAL ON Stocks --- - ----- ---�-- �150 , 000. 00 Subscription Payable --------- -- f-150 , 000. 00 # S ubs c ription Payable ~- ~150 , 000 . 00 Ren tal Income (196~) ----- -- - - -- � 30 , 000. 00 Deferred Income - ----------- --- 120 , 000. 00 PANDAR ENTlZ P1 ~ BS , I N..Q.. S ubscription Re ceivable -~150,000 . 00 Capital Stock - - --- ----- ------- 150, 000. 00 #

DECISION CTA C.t-\SE No. 2013 8 Rental Expense -------- � 30 , 000. 00 Prepaid Rent -------- 120, 000. 00 Subscription Re ceivable ---- - --- ~150 , 000 . 00 # In determining the net income of petitioner in this case , the method of accounting regularly employed by him , if it Clearly refle cts income , shall be considered . Unless such method dic tates otherwise , all re ceipts shall be included in gross income for the year vlhen they a re a ctually re ceived. Depending also on such method of a ccounting , deduc tio.ns are to be taken for the year in which "paid or a ccrued 11 or 11paid or incurred . 11 No uniform method of accounting is prescribed in Sectio.n 38 of the National Internal B.evenue Code , in relation to Sec . 166 of the Income Tax Regulations . � Consequently , each taxpayer shall adopt such forms and methods of accounting best suited for his purpose . There are , however , two principal methods of ac counting widely used by taxpayers , namely: (1) The cash receipts and disbursements method :� better knmvn as the "c ash basis 11 method ; and ( 2) The accrual basis method . Cash Nethod . If the income is determined purely by reference to the changes in the cash position of a taxpaye r, it is said that he employs a 11cash method 11 or that his income is determined on the 11 cash receipts and cash disburse -

DECISION ~ CTA CN3E No. 2013 9 menm bas is . 11 In short, this me thad consists of deter- mining the amount of cash received , and the amount of cash expended. The � excess o~ the receipts over ex- penditures is income and the excess of expenditures over receipts is a loss . A cash bas is taxpayer may be required in some cases to add to his income actually receiVed the arnou..11t of other 1ncome considered to have been constructively re- ceived. For instance , interests on time and savings bank deposits are income to the depositor when credited, even though be is on th-3 cash bas is � .;.C.;.ot;.;;1s;:.t.;:;.;r;.u;.;:.c;.;t i ~~-receiPt� It means that vJhile the �income is not actually 'in the possess ion of the taxpayer, it is so much "ltli thin his control and dis posit ion amou..11ting to actual receipt . accrual_ JlE..tpoq_. This is the method of determining income by allot -. ing ;i.,n_gome and eJ�P..flllS es :to which ear~. The basic rules in the ac crual method are: (1) The right.....tQ._receive an, item ot income (as dis - tinguiSidfrom actual receipt) determines its inclusion in gross income under the accrual method. (2) A deduction car!not be accrued until an actual_ liability is i,ppurre_d_.

DECISION - � CTA CASE No . 2013 ' �I ' 10 ld'ter discussing briefly the tvlO methods of account- ing relevant to this case , we are going to detarmine whether t he advance rental of ::150 , 000. 00 allegedly re- ceived by petitioner Porfirio .Y. Ascalon in 196lt -is ta~able to h .irn in that year despite the fact t hat he is on the accrual bas is of accounting . Following the accrual method of accounting , �peti- � t ioner has reported and included the annual rental of ~30 , 000 . 00 in his income tax returns for the . crop - years 1964�, 1965, 1966 , 1967, and 1968 and has paid the in- come taxes corre~pondin gly to tha 5- year period . The annual declaration of rent a l income and the yearly pay- ment of income tax were disre gar ded by respondent be - cause , in the balance sheet a ttached to petitioner 's 196lt income tax return , Hr . As cal on declared only 30, 000. 00 as rental income in 196lt and treated the balance of i!:l20 , 000. 00 as deferred income under the lia- bilities section of his balance sheet; the said amount was likeivise reported and credited by t he lessee, Pan- dar '""n te rpr is es , Inc . , in its 196lt income t a x ret llrn as 11Prepaid Rent 11 � Ordinarily , income is constructively received if dllly credited on the books of the taxpayer . On this point, Revenlle Reglllations No. 2 of' the Department of Finance , otherivise knovm as the Income Tax Reg ulations , proVide:

>' DECISION - CTA CliSE No. 2013 11 "Sec . 52. Incoms; cops truct:i;V'3ly re- ceiVed. - Income Hhich is credited to t he account of or set apart for a taxpayer and \�rhich may be drmvn upon by him at any time is subject to tax for the year dur- ing which so credited or set apart, al- though not then actually red~ce9 to pos- sess ion. To constitute receipt in such a case the income must be credited to the taxpayer withou.t any substantial limita- tion or restriction as to the time or manner of payment or condition upon which payment is to be made . .A book en try , if made , should indicate an absolute transfer from one account to another. If the in- come is not credited , but is set apart, such income must be unqualifiedly subject to the demand of the taxpayer . vmere a corporation contingently credits its em- ployees with bonus stock , but the stock i9 not available to such employees until some future date , the mere crediting on the books of the corporation does not constitute receipt . 11 (Revenue Regula- tions No . 2, Sec . 52. ) Section 52 of the Income Tax Regulations appears to be anexception to t he :methods governing cash or accrual basis of accow1ting income . But mere crediting of an i ncome to t he taxpayer is not sufficient to .constitute constru.ctive receipt. It must be shown that (1) the i ncome is available to him; (2) the debtor is able and ready to pay him; (3) his right to receive is not restricted; and (4) his failure to receive is the result of the exercise of his own choice . (C� .". Gullet , 31 BTA 1067; William Parris , 20 BTA, 320. ) On the part of Pandar Enterprises , Inc . , the pre -

DECISION - CTA CJ1SE No. 2013 12 paid rent of ~120 , 000. 00 should be treated as capital \ e~p.Etnditure . It cannot deduct in 196lt the full amount .. of prepaid rent as a business expense but it must de- � duct them proportionately over the remaining four (lt) years of the lease , t hat is , 1965 , 1966 , 1967 and 1968� . This procedure should be followed even though t he pre - paid rent of i=l20 , qoo. 00 had been taxed in full to , the less or i n t he year of receipt (See Pig & lm is tle Co.. , 9 BT 668; Nain & McKinney Building Co . v . Conmissioner, 113 -F'. 2d , 81). O.n t he part of Hr. Porfirio V. Ascalo.n , the ad- vance payment of f1l50 , 000. 00 is taxable income to him in 196lt if the saig pazm�pt is actually ang in reaiitz pre -.r:>..a.id rental � And this is true even thoug h Hr � .lis - �cal on is on the accrual or the cas h method o:f a ccount- .ing . (Hyde Park Realty, Inc . v . Co'mmissioner , 211 F . 2d lt62J . Cf . Evansville Courier v . Commiss ioner ~ 62 F ed 232. ) The lessor in either case is required to incluq.e the entire amount of the advance rental in h is gross income in 1 96lt when s u.ch advance rental \.Jas re - ceived by him. Hmv-ever , the advance payment or 12repaid rental 1� ta~e to t he lessor o~~ he receiY~ t~~ ~J:Ud..er a cla;i.m or right anQ, vli thout x.:es triction as to -. its use. LH.enwick v . Un ited States, 8'7 li'. 2d . 123 (CCA 7th, 1936); Hort v. Commissioner , 313 u. s. 28 , 85

DECTI3ION - CTA -CAS "" No . 2013 13 L. Ed . 1168 , 61 S . Ct. 757 (1941) ; Neils S chultz , 44 BTA 146; Edwin B. DeGol i a , 4o B':tA 845 ; itJarren Service Corp. , 3 9 BTA 856 ; George .E. Baker Estate , l3 BTA 562; 2 Mertens , l7ederal Income Taxation , 171 , 1942 ed . 7 Otherwise , such� advance rental should be apportioned . - over the term of the lease . (O' Day Investment Co., 13 BTA i230 ; Louis Rothenberg , 5 BTA 666 ; R. H. Hazlett , 10 BTA 332; Roby Realty Co. , 19- BTA 696; A. T. S chiro , Inc ., 20 BTA 10~6; Do uglas Properties , Inc ., 21 ' BTA 347 ; vlilliam Penn. Hotel Co ., 23 BTA 566 ; Nichigan Central R. S . Co ., 28 BTA 437 ; .tUlie E. Turbeville , 31 BTA 283; Crile v. Commissioner , 55 F. 2d 8o4; and Jennings & Co., Inc . v . Commissioner , 59 F. 2d 32. ) In one case , however , , it has been held that where pay- ment to be applied to the r ent for the last year of the term of the lease is made to the lessor upon the exe c u- t ion of the lease and is r eceived under a present claim of full ownership and subject to his unfettered command , the payment is income to the lessor ~n the year of receipto LHirs"ch Improv-:=men t Co. , BTA lV:emo. Op ., DKT 105492 (Oct. 6 , 1942) . aff ' d 143 F 2d (CCA 2d , 1944).7 In determining \vhether t he advance rental of i-"150 , 000. 00 was constructi'9:eJ.;y receiVed by petitioner in 1964, the follm-ring questions may be asked: (1) Is the rental income of �150 , 000. 00 available to peti-

� D:SCISION - CTz CASE No . 2013 t ioner? (2) Is t he debtor Pandar Ent erprises , Inc . able and ready to .Pas him ? (3) Is the right of peti - tione r to receive the rental income of 150 , 000. 00 not restricted ? and (4) Is the f a ilure of petitioner to receive the advance re ntal t he r esult of the exercise of bis m�m choice? These quest ions s h ould be answered in the negative � . The alleged advan ce rental of it150, 000;oo is not available to pe titioner in 1964 becau5e at that time, Pandar ~nt erpr ises , Inc . has only a paid-up c apital of 5o , ooo. oo. 'rhe s hares of stock of the s aid corpora- tion 1-Iith a par value of f l50 , 000. 00 is likewise n ot available to petitioner inasmuch as the immediate is - suance thereof is subject to certa in condit ions imposed in the miscellaneous lease contract which provides , among others , as follo1tfs: 11x x x . That since most of the prope rties herein are mortgaged to t he Philippine Natio nal Bank for crop loan �p ur - poses in orde r not to hamper t he operation of t he enterprise , the L7SSOR shall con- tinue to deal vlith the said bank in his ovm name but this contract shall be sub- mittedto the ~lippine Na tional Bailie in order to approve the a�sqmption of th~ a,ccoupt� of the I.!IJSSJ~J;l! he r!? j.n for vlhich t he p~opertie� IDQrtgag~d to the Philippin~ Na tional Bank shall co ntinue to be mort - a ed for cro and othe r loan ur- oses . Underlining supplied; p. 68 CTA rec . ) It is clear from the foregoing stipulations that

DECISION CTA CAS E :No . 2013 15 Pandar Enterprises , Inc. is not ready to pay petitioner . in shares of stock valued at xtl50 , 000. 00 and that peti- tioner does not have th<:; right or unfettered command to receive the advance rental of r~l50 , 000. 00 because the payment thereof is subject to certa in restrictions - the approval by the Philippine Na tional Ba nk of the contrac t of 11Lease , Acquisition of Hights and Expenses with Assumption of Obligations and Income'' executed by and bet'iveen petitioner Porfirio V. 1-\scalon and Pandar Enterprises , Inc. Accord ingly , we hold tha t the disputed rental -of �150 , 000. 00 was not constructiVely receiVed by peti- tioner in 1964 because there can be no construc tive receipt of the advance rental until the condition or restriction imposed by the lease contract is removed. (See Se c. 52 , Inc ome Tax Reg ulations ; C. T. XX- 1 , 179 ; Richard Esta t e v . Connis sioner , 1 50 F L2d/ 837 ; Ol- s on , 24 BTA 70 2, aff ' d 67 F L2d7 726 , certiorari de - nied , 292 u. s . 637 ; Denny , 33 BTA 738. ) In the light of the resolution of this Co urt bn the first and second issues , we deem it unnecessary to pass on the third issue . li!BER8~FOHE , the dec is ion of the res nondent Commis - sioner of Internal Revenue holding petitioner subject to the 1964 deficiency i ncome t ax of ~65 , 663. 35 , in -

DECISION - CT1 CASE No. 2013 16 elusive of interest , is reve.rsed . Accordingly , the said assessment is hereby cancelled and declared of no force and effect. \Hthout pronouncement �as to � costs . SO ORDE �D. Quezon City , April 25, 1973 . mJ:AN r-:. UNi-\LI Presiding Judge ~--~-~ RANOF 1 . AVli.NCE~TA Associate Judge