CTA Case No. 2607 (Decision)

~EPUBLIC OF 1"1U. PRILJ PPimS l coiJRT OF TAX APPEA.LS N: ~.70N ClT NELLY MAGALLANES LOPEZ, Petitioner 1/ - versus - C . T . A . C A~E NO. 2607 THE COMMISSIONER OF INTERNAL REVENUE , Respondent . X - - - .- -------X DE C I S I 0 N This i s an appeal from the dec i sion of the Commissioner of Internal Revenue assessing against and demanding from petitioner Nelly Magallanes Lopez the sumcr ~250,965.94 as deficiency income tax for 1963. On January 16, 1963, petitioner Nelly Magallanes Lopez and her husband Carlos P . Lopez {now deceased) ~ad entered into a contract, denominated a s "Deed of Sale Wi th Assumpt i on of Obligation", with the Macdem Enterprises Co . , Inc., hereinafte r referred to as MACDEM for short, in which they transferred their properties to the l atter , consist i ng of the f ol l ow i ng : 21 !)

DECISION - CTA CASE NO. 26 07 - 2- SCHEDULE OF ASSETS SOLD 'IO AND LIABILITIES ASSUMED BY MACDEN ENTERPRISES CO. INC. FROM MR.. & MRS. CARLOS T. LOPEZ ASSETS RESERVE FOR B(X)K VALUE C 0 S T DEPRECIATION Buildings & Laborers Iil68,703.09 Jil22, 281.04 Jil46,422.05 Quarters 71,827 . 32 62,338.64 9,488.68 Tractors & Accesso- ries 2,772.01 2,772.01 16,881.38 30,288.89 13,407.51 1,684 .63 Roads, Bridges & 3,851.37 Culverts 2,166.74 76.84 3,851.37 Delivery Equipments 3,221.43 519.38 Other Form Equipments 6,294.40 24,166.00 Farm Tools & Imple- 30,880.00 5,775.02 6,714 .00 3,027.00 ments 3,027.00 Office Furniture & Fixtures Service Car L ive s t o c k s TOTAL Jil220,942.35 Jilll8,676.39 Jill02,265.96 Agricultural Land - Hda. Los Angeles 240,000.00 Urban .Lots 17;152.89 Residential Building 70,570.85� TOTAL ASSETS . Jil429, 988.85 It was stipulated in consideration of the transfer of the above real and personal properties in the said contract - That for and in consideration of the sum of FOUR HUNDRED TWENTY NINE THOUSAND NINE HUNDRED EIGHTY EIGHT PESOS AND EIGHTY- FIVE CENTAVOS (P429,988.85) 1 Philippine Currency, which the VENDEE (MACDEN) shall pay to the VENDORS (Nelly Magallanes Lopez and Carlos P. Lopez) in the manner as herein- after provided. The �vENDORS hereby SELL, CEDE, TRANSFER and CONVEY in favor of the VENDEE , its successors and assigns, the above described parcels of l and , together wi t h all bu i ldings and improvements' exist- ing thereon, subject to the f ollowing terms and condit i ons; 22 0

DECISION - CTA CASE NO. 2607 - 3- 1. That in view of the fact that the VENDORS have unpaid subscriptions to shares of stock ot the VENDEE amount- ing to One Hundred Twenty Thousand Pesos (Pl20,000.00) the said amount shall be deducted fr om �the purchase price afore- mentioned and the subscription to shares of stocks of the VENDORS herein shall be considered as fully paid. That the VENDEE shall likewise assume the liabilities of the VENDORS as of October 31, 1962 in the total sum of Two Hundred Ninety Seven Thou- sand One Hundred Fourteen Pesos and Ten Centavos (P297,114.10), as appearing in the books which includ~s the accounts with the Philippine National Bank by way of crop loan, time loan and palay loan. XXX XXX XXX 4. That the balance of Twelve Thou- sand Eight Hundred Seventy-Four Pesos and Seventy-Five Centavos (Pl2,8J4.15} shall be paid by the VENDEE to the VENDO~S with- in a period of four (4} years from and after the date of the exemption of this contract. (Exhs. B, B-1, B-2 & B-3.} Petitioner Nelly Magallanes Lopez and her deceased husband have transferred their properties in consideration of, or in exchange for (1) .the assumption by MACDEM to pay their liability of P297,114.10 with the Philippine National Bank consisting of crop, time and palay loans; (2) the crediting of Pl20,000.00 as payment for the unpaid MACDEM shares subscribed by petitioner and her hus- band; and (3) .the payment of the sum of Pl2,874.75 to petitioner, which is the balance of the consider- ation of the aforesaid contract of P429,988.85 and to be paid by MACDEM. 22 1

DECISION - CTA CASE NO. 2607 - 4- MACDEN in return for the tran sfe r of the said properties, accordingly, credited the sum of Pl20,000.00 , and issued the remaining unpaid shares. It also assumed the liabi lities of petitioner Nelly Magallanes Lopez and her late husband Carlos P. Lopez with the Philippine National Bank consisting of P .N .B. crop loan for 1962 to 1963, time and palay loan, and, apparently, including accounts payable, accrued audit fees and SSS premiums, all in the total sum of ~297,114.10. On the basis of the transfer made by the spouses to MACDEN of their properties, the said agreement was considered by respondent as an exchange of said properties with the shares of stocks and assumed liabilities and monetary consideration by the MACDEN. As a consequence of this asserted exchange of assets between Nelly Magallanes Lopez and her late husband, on the one hand, and MACDEN on the other, the appreciation made by respondent of the value of the real and personal properties aforesaid given in exchange, i.e., from their book value (ii429, 988.8 5) _to the alleged fair market value (~964,738.37) ~constitute the gain realized in the exchange. The amount of ~429,988 .85 above consti- tutes, therefore, the book value of the assets or 22 2

DECISION - CTA CASE NO . 2607 - 5- properties given in exchange i n consideration of the aforesaid liabilities assumed by MACDEN from the Phi li ppine National Bank in the a mount of ~297,114.10, of the credit of ~120,0 0 0.00 in pay- ment o f the unpaid MACDEN shares of stocks: and account recei v able of ~12,874.75, payable by MACDEN to petitioner in 4 years from 19~3. By deducting from the appraised fair market value cf ~964,738.37 of the properties exchanged by respondent with their net book value of ~4 29,988.85 , respondent had con- sidered the increase in the value of the assets given in exchange which is ~542,133.30, 50% of which (or ~122,755.15) _is deducted from ~542,133.30, the said resulting amount of ~419,378.15 is, there- fore the gain assertedly realized in the exchange. This amount, in the report of Examiner Isabelo Romualdo (Exh. 5, p. 8, BIR rec.) ~ is s u bject to deficiency income tax for 1963 of ~250 , 965.94, in- elusive of ~% interes t , as was finally computed and determined 0y respondent. This determination of profit was based upon or anchored on the holding in a Resolut i on of the Supreme Court in the case of Collector of Internal Revenue vs. Binalbagan Estat e , Inc. G.R. L-12752, promulgated on March 21, 1965 , that "x x x Such i ncrease in value of the I.

DECISION - CTA CASE NO. 2607 - 6- assets should have been taxed as profit realized by Binalbagan from the exchange of assets for the Biscom shares. x x x" Based on this finding, respondent issued on April 9, 1969 an assessment against petitioner in the amount of ~250,965.94 inclusive of interest, as deficiency income tax for 19 ~3 (Exh. 1, p. 36, BIR rec; Exh. N-1, Brown Envelope) ~omputed as follows: 64 - AR - 69/63 Net taxable i ncane as per investigation ~419,378. 15 Less: Personal & additional exemption Net income subject to tax 7,000 . 00 Tax due thereon ~ 412 ,3 7 8.15 Deduct.;: Arrount already paid ~2 12,683.0 0 Deficiency tax due Add: ~%monthly int. fr. 4-16-64 to None 4-9:-6~ (18%} ~212,683.00 38,282.94 TOTAL AMJUNT DUE & COLI...B:TIBLE ~250,9 6 5.94 Succ intly, this assessment was explained to have been arrived at by respondent as follows: "The net taxable income amounting to ~419,378.15 re presents t.he gain you realized from the exchange of your pro- preties in 1963 with the shares of stocks of MACDEN ENTERPRISES CO., INC., Under Section 35(c) (1} of the National Inter- nal Revenue Code 'as implemented by Sec- tions 140 & 141 of Revenue Regulations No. 2, the: difference between the fair market value of the properties at the time of the exchange and its original cost, is income rea~ized and subject to income tax. Under the Supreme Court 2 2 �l

.,. DECISION - CTA CASE NO. 2607 - 7- decision in the case of the Col- lector of Inter nal Revenue vs. Binalbagan Estate, Inc. (G.R. No. L-12752, March 21, 1965), it was heid that the increase iri the value of the assets over its cost should be taxed as profit realized from the exchange of said assets. Con- sidering the fair market value of your assets at the time of exchange as ~964, 738.37 and its cost amounted only to ~422,605.07, the gain real- ized amounted to ~54L,l33 .30. Since some of the assets exchanged are capital assets, only 50% of the gain realized is returnable for income tax in 1963. Subtracting, therefore the amount of ~122,755.15 representing 50% of the gain real- ized from the exchange of capital assets from ~542,133 .30, realized from such exchange." In a memorandum dated April 29, 1969, peti- tioner contested the assessment of deficiency income tax served against her and assailed, among others, the manner and procedure followed by Examiner Isabelo J. Romualdo in his examination and alleged that the asses- ment in question is arbitrary and without legal and factual basis. (Exh. 2, pp. 53-69, BIR rec.) On September 16, 1970, Deputy Commissioner of Internal Revenue, Conrado P. Diaz, wrote a letter to petitioner, calling her representative Francisco E. Maravilla to a conference on September 30, 1970 to enable the latter to present her side of the case. (Exh. 3, p. 74, BIR rec.) � During the said confer- ence, petitioner submitted a letter on that day in 225

--....- ....... DECISION - CTA CASE NO. 26 0 7 - 8- support of the arguments presented in her original memorandum dated April 29, 1969. (Exh. E, pp. 102- 114, CTA rec.) . And, on October 15, 1970, petitioner submitted ano ther rejoinder to the memorandum ques- tioning the finality of respondent's assessment. (Exh. 4, pp. 82-87, BIR rec.) On December 7, 1970, Conrado P. Diaz , Acting Commissioner of Internal Revenue (Exh. 5, p. 93, BIR rec.) '� acting on the letters of protest of peti- tioner, denied the same in this wise: "In reply thereto, please be informed that after considering the points raised said letters, this Office could not find its way clear to sustain said request. The a~sessment was seasonably made by the Commissioner, thru his authorized re- presentative, the Regional Director of Revenue Region No. 14, within the period prescribed by law. Furthermore, your contention that the transfer of assets was an exempt transaction finds no basis, for under Section 35(c) of the Tax Code, implemented by Revenue Reg,ulations No. 2, otherwise known as the Income Tax Regula- tions, the difference between the fair market value and the original cost of p roperties exchanged for shares of stock is considered either income derived or loss sustained. "In view thereof, you are hereby requested to pay said amount to the Col- lection Agent of Bacolod City within ten (10) days from your receipt hereof in order that �this case will be closed and termi- nated." Again, this denial was protested by petitioner in a memorandum to the Acting Commissioner of In- 22G j

DECISION - CTA CASE NO . 2607 - 9- ternal Revenue, dated December 21, 1970, alleging �that r e spondent had neither presented any evidence to justify his position nor presented any argument against petitioner's stand. (Exh. 6, pp. 95-113, BIR rec . ) On February 26, 1974, respondent, in a letter referring to the a bove memorandqm (~xh. 7, p. 153, BIR rec. ) ,_ denied petitioner's protest stating in the ultimate paragraph thereof, as follows: "In view thereof, you are hereby requested to urge your client Mrs. Nelly Magallanes Lopez to pay the amount of ~250,965.94 representing deficie ncy in- come tax and interest for the year. 196 3 within te n days from receipt hereof oth er- wise this Office will be constrained t o enforce collection thereof through the remedies prescribed by law." This denial was a dm ittedly received by pet.i tioner on March 13, 1974. (Exh. 9, par. XXVI, p. 9, CTA rec.) And on the same da t e, respondent filed a complaint for the collection of deficiency income tax against petitioner with the Court of First Ins- tance of Manila in Civil Case No. 93652. (Exh. K, pp. 147-149, CTA rec.) A copy of the complaint was then received by petitioner Nelly Magallanes Lopez on May 3 , 1974. (See Exh. 9, supra, par. XXVIII, p. 10, CTA rec.) On May 11, 1974, petitioner's counsel inter - posed the present appeal in behalf of petitioner. 227

- DECISION - CTA CASE NO . 2607 - 10 - On Jul y 19, 1 974 , respondent, in his answer /' to the petition f o r review, alleged among others, that the appeal was filed beyond the thirty-day period prescribed in Section 11 of Republic Act No. 1125, and, hence, this Court has no jurisdiction over the case. However, from the f acts disclosed during the preliminary hearing, the alleged lack of jurisdiction did not appear indubitable. Hence, this Court, in the interest of justice and expc.: �.Hency, preferred the jurisdictional issue to be considered togethe r with the mer its of the case. The issues, therefore, brought for determination in this app~al are as follows: 1. Whether or not this Court has juris- diction to take cognizance of the case; 2. Whether or not the right of respondent to assess petitioner for the 1963 income tax has already prescribed; and 3. Whether or not the transfer of peti- tioner's properties in 1963 to MACDEN in con- sideration of the issuance of 1,600 shares of stocks and assumption of the former'~ liabi- lities or obligations gave rise to a taxable income. With respect to the first issue, respondent maintains that petitioner's appeal was filed beyond the thirty-day period prescribed in Section 11 of Republic Act No . 1125 and , therefore, the same cannot be t aken cognizance by th i s Court for lack of juris- dict i on. Respondent claims that the final decision 22 8

- DECISION - CTA CASE NO . 26 0 7 - 11 - appealable to this Court was the letter-dec i s i on dated February 26, 1974 . He further asserts that petitioner ' s letter of March 14 , 1974 , being mere l y 12�2-forma since it raises new grounds, did not stop the running of the thirty-day period counted from receipt of the decision wi thin which to appeal to this Co urt. Petitioner admitted that the final and defi- nitive assessment was made in the letter da t ed Febr u ary 26, 1974. <see Memorandum in Opposit ion to Respondent BIR Comm issioner's Verbal Motio n To Dismiss, pp. 176-185, CTA rec.). However, she can n ot acc~pt the view that the requ est for re- consideration filed by her o n March 14, 1974 did not have the effect of suspending t he running of the thirty-day period for appeal because it is E.E.�-forma. It must be noted that the said letter of March 14, 1974 of petitioner was actually the first request for recon sideration of the dec i - sian on the disputed assessment rendered by res- pendent. (See Noblejas vs . Commissioner of Internal Revenue, CTA Case No. 1923, Resoluti o n, October 4 , 1968 . ) . That being so, it had the effect of suspending the running of the period 22!1

DECISION- eTA CASE NO. 2607 - 12 - of appeal. Being the first request for recon- sideration, it cannot be seriously said that such request is pro-forma even though the defenses contained therein may be the same as those asserted in the previous communications of petitioner to respondent. The period to appeal started to run only on May 4, 1974, a day after receipt of notice of the complaint for collection tiled by res- pendent in the Court of First Instance of Manila, which complaint is tantamount to a denial of petitioner's request for reconsideration. (Re- public vs . Lim Tiang Teng, G.R. L-21731, March 31, 1966; SCRA 584. ) From May 4, 197 4 , when notice of the complaint was received, to May 11, 1974, when the present appeal in this Court was filed, only eight (8) ~ays had elapsed. Conse- quently, this Court has jurisdiction over this appeal. . Coming now to the second issue, pe t itioner contested the right of respondent to assess the deficiency income tax against her claiming that the proposed assessment of April 9, 1969, in the amount of il250,965.94, "did not become final for the reason that the assessment was signed only by 230

-- DECISION - CTA CASE NO. 2607 - 13 - the Regional Director and his power to make fi nal assessment does not include those that exceeds PlO,OOO .OO. She contends that respondent rendered his final assessment only on February 26, 1974, or beyond the prescriptive period of five years, invoking the provisions of Section 331 of t he Tax Code. It must be noted, howeve~, that respondent communicated the discovery of petitioner's omis- sion to file her income tax return for 1963 on March 31, 1969. There being a failure to file a return, an assessment can be made and the tax im- posed thereon collected within a period of 10 years from the date of the discovery of the omission. (Republic vs. Tan, 28 SCRA 325.) In the present appeal, petitioner made no allegation nor presented any evidence to show that her income tax return for 1963 had been filed. Therefore, the fi ve-year period within which to assess, prescribed in Section 331 of the Tax Code, is not applicable as said period refers to cases where returns are filed. The only period petitioner can invoke is the ten-year period provided in Sec- tion 332 of the same Code within which to assess the tax. Th e five-year period within wh i ch to assess the t ax by respondent applies only when a return is

DECISION - CTA CASE NO. 2607 - 14 - fil ed pursuant to Section 331 of t he Tax Code, and the prescriptive period o f ten year s within which to assess applies only wheneve r an i ncome tax re- turn i s not fil e d, pursuant to Section 33 2( a) of the Tax Code . (Tan Guan vs. Nable, No. L-~ 8598 , July 23, 1968 ; 24 SCRA 93.) Counting , therefore, fr om March 31, 1969, when the discovery of omission or failur e to file re turn wa s discovered, to Apr il 9, 1969, the date of the assessment, it i s clear that respondent assessed the taxpayer wi t hin a period of ten years from the discovery of the omission to file a return. Petiti oner's plea of prescription cannot, t h~re fore , be sustained. Corn ing now to the third issue, peti tioner con- tends that the transfer of their (petit i oner and her deceased husband) _properties to MACDEN is a sale and, therefore, there is no taxable exchange. It is contend ed that the assets of petitioner, and that of her l ate husband, with a cost or net book value of ~429,9 8 8.85, having been sold for the same amount as its cost or net book value, whic h consist of ~297,114.10 repre senting assumed li abilities with the PNB and others; the credit of the s um of ~ 12 0,0 0 0.00 to satisfy the unpaid subscription of the MACDEN shares of stock; and the accounts payable of ~12,8 7 4.75, t o be s at isfied or paid by MACDEN within a pe r iod of f ou r

- DECISION - CTA CASE NO. 2607 - 15 - years from the date of contrac t, there is no t ax- able gain as contemplated in Section 35 (c ) ( 1 ) _of the Tax Code. She contends, i n tne alternat i ve, that assuming this transact i on as an exchange , a position taken by respondent, and assuming that the fair market value of the assets of petitioner was at the time ot the alleged exchange P964,738.35 as arrived at by Examiner Romualdo, and the fair market value of the 1,600 shares of stock received in ex- change as determined by the same Examiner to be either P422,605.07 (Exh. 11, p. 31, BIR rec.) _or P654,749.52 (Exh. 3, pp. 12-14,BIR rec.) _there would be a loss t9 petitioner, instead of a taxable gain. This was shown in the foregoing computatio ns by peti- tioner. (pp. 20 & 21, Memorandum of Petitioner . ) Total fair market value of real properties as arbitrarily fixed by BIR Examiner Isabelo J. Romualdo ������������� P964,738.37 Less: Fair market value (Cost of 1, 600 shares of Macden Enterprises Co., Inc. per Exhibit II) � � � � � � 422,605.07 Net loss to petitioner ������ (P542,13 3 .30 ) XXX XXX XXX Fair market value of properties arbitrarily given by BIR Examiner Isabelo J. Romualdo �� . ����� P964,738.37 Less : Fair market value (cost of 1,600 shares of MACDEN per Exhibit 3) � � � � � � 654,749.52 Net loss to petit i oner �. � �. (P309,988.85) 23~

DECISION - CTA CASE NO. 2607 - 16 - She concluded that there being a loss, there was no i ncome realized from the exchange or received by petitioner which is ta~able pursuant to Sec- tion 35(c) (1) of the Tax Code. Finally, she con- tends that:. the ruling in the� case of Collector of Internal Revenue vs. Binalbagan Estate, Inc., G.R. L-12752, promulgated on January .30, 1965 is not applicable to the instant case. On the other hand, respondent insists that the deed of transfer between petitioner Nelly Magallanes Lopez and MACDEN is not a deed of sale under precise legal contemplation, and that the transactiory is actually an exchange where the valu- able con siderations received under the transfer are the relief from all her obligations of P297,114.40 with the Philippine National Bank, etc. , the release of the 1,600 shares of stock upon the application of the sum of Pl20,000.00, which is the consider- ation to the~ unpaid subscription; and the accounts receivable fr om MACDEN of Pl2,874.75 . It is asserted that since there was an exchange of property f o r assets, the increase from the book value or costs of the petitioner's properties of P422,605.07 (should be P429 , 988 .85) _to its fair market value as found by respondent in the sum of P964, 738.37, the differ- ence in the amount of P542,133 .30, which is an \

�- �---- DECISION - CTA CASE NO . 2607 - 17 - appreciat i on or increase of the value of. the assets, is under the asset.ted ruling of the Supreme Court in the case o f Collector of Internal Revenue vs . Binalbagan Estate Inc., G.R. L-12752, January 30, 1965, taxed as profit realized in the exchange of said assets. Respondent concludes that since some of the assets exchanged are capital assets, only 50% of such gain in the sum of Pl22,755.15 realized in 1963 should be deducted from the gain of P542,133.30 realized in the exchange, and the balance of P419,378.15, being the net gain realized from such exchange (Exh.l, p. 36, BIR rec .) _is, therefore, subject to a defi- ciency income t.ax for 1963. In the proper disposition of the third issue, i.e., whether or not the transfer of petitioner's properties or assets to the MACDEN, in consideration of the latter's issuance of its 1,600 shares of stocks and assumption of the forme r' s liabilities, is a taxable gain on the sale, or on the exchange of property, it is best to cite and restate the applicable provisions of law, which is Section 35(c) (1) of the National Internal Revenue Code, as amended by Republic Act No. 1921, approved on June 22, 1957. Said Section 35(c) (1 ) ~ as amended, provides as follows: I 235

DECISION - CTA CASE NO . 2607 - 18 - Sec. 35 . Determination of gain or loss from the sale or other disposition of propertye - The gain derived or loss sustained from the sale or other dis- pos ition of property, real, personal, or mixed, shall be determined in accord- ance with the following schedule: (a) In the case of property acquired on or be!ore March first, nineteen hundred and thirteen, the fair market price or value of such property as of March first, nineteen hundred and thirteen. (b) In the case of property acquired on or afier March first, nineteen hundred and thirteen, the cost thereof if such property was acquired by purchase or the fair market price or value as of the date of the acquisition if the same w~s ac- quired by gratuitous title. (c) Exchange of property - (1) General rule. Except as herein provid~d; upon the sale or exchange of property, the entire amount of the gain or loss, as the case may be, shall be recognized. This provision is implemented by Section 136 of the Revenue Regulation No. 2, known as Income Tax Regulation, as follows J Sec. 136. Basis for dete rmi ning, gain or loss from sale of property. - For the purpose of ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such property, or in the case of property which should be included in the inventory, its latest inventory value. But in the case of pro- perty, acquired before March 1, 1913, when its fair market value as of that date is in excess of its cost, the gain to be inc luded i n gross income is the excess of the amount realized therefor over s uch fair market value. (See Illustration I,

DECISION - CTA CASE NO. 2607 - 19 - section 137 of these regulations) Also in the case of property acquired before March 1 , 1913 when its fair market value as of that date is lower than its cost, the deductible loss is the excess of such fair market value over the amount realiz.ed therefor. (See Illustration II, Id.) No gain or loss is recognized in the dase of property sold or exchanged (a) at more than cost but at less than its �fair market value as of March 1, 1913. (See Illustrat.ion III, Id., (Id.), or (b) at less than cost but at more �than its �fair market value as of March 1, 1913. (See Illustration IV, Id., Id.) In any case, proper adjustment must be �made in computing gain or loss fr om the exchange or sale of property for any depreciation or depletion sustained and allowable as a deduction in c omputing net inco me~ the amount of depreciation previo usly charged off by the taxpayer shall be deemed to be the true depreciat ion sustained unless shown by clear a nd convincing evidence to be incorrect. x x x ... This provision of law is substantially prov ide d for in Sections 1 001 and 1002 of the us Revenue Code of 1954, which equally provides the determination of the amount of gain or loss arising from the sale or other disposition of property and reproduced in Sec- tions 111 and 112(a) of t he US Internal Revenue Code of 1939� (Jacob Mertens, Law of Federal Income Taxa t ion , 1954-~8 Code, 1959 Ed., p. LXX.) Other US Internal Revenue Code provisions, such as Sections lOll and 1012, entitled Adjusted Basis for Determining Gain or Loss and Basis of Property-Cost, are provisions fr om which our l aw (Section 35(c ) (1) of the National Internal 2 37

DECISION - CTA CASE NO . 260 7 - 20 - Revenue Code) ~as been equally taken . Sections 1001, 1002, 1011 , 1012 and 1016 of the US Internal Revenue Code of 1954, to the extent here pertinent, are quoted as follows: SEC. 1001. DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS. (a) Computation of Gain or Loss. - The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in Section 1011 for deter- mining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized. (b) Amount Realized.- The amount realized �from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received. In determining the amount realfzed - XXX XXX XXX XXX XXX XXX (c) . Recognition of Gain or Loss.- In the case of a sale or exchange of property, the extent to wh ich the gain or loss determined under this section shall be recognized for purposes of this sub- title shall be determined under section 1002. SEC . 1002. RECOGNITION OF GAIN OR LOSS Except as otherwise provided in this subtitle, on the sale or exchange of property the entire amount of the gain or loss determined under Section 1001, shall be recognized: 23 8

DECISION - CTA CASE NO. 2607 - 21 - SEC . 1 011. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS . XXX XXX XXX SEC. 1012. BASIS OF PRO~ERTY-COST . The basis of property shall be the cost. of such property except as othe r- wise provided in this subchapter and subchapters C (relating to corporate distributions and adjustments), K (re- lating to partners and parU.nerships), and P (relat.ing to capita l gains or � losses). The cost of real property s h all ncit include any amount in res- pect of real property taxes which are treated under Section 164(d) as imposed on the taxpayer . " A running commentary of these provisions which paral- lel our present law (Section 35(c) (1) ?f the National Internal Revenue Code) _sho w that, under said Sec- tion 1 0 01 of the aforesaid 1954 US Inte r nal Revenue Code, in the determinat.ion of the amount of g,ain or l o ss arising fr om the sale o r other disposition of property, it was the obvious intention of. the US Congress to maintain the same rules that have been laid down under prior laws, as there is identity of the sen- tence structures of these provis i ons with the old ones. (Mert ens , Law of Federal Income Taxation, Cod e Commentary, Section 1001:1 Vol II, Ch. 1, Subch. C- Page 6.) That be ing the rule observed, the gain or loss from the sale or disposition o f property is de ter min ed

DECISION - CTA CASE NO. 2607 - 22 - by the difference between the "amount realized" and the "adjusted (cost) basis" of the property. So that an excess of the "amount realized" over the adjusted cost basis results in gain, and an excess of the ad- justed cost basis over the "amount realized" results in a loss. This method of computing gain or l oss contemplates that, from the amount realized, there shall be withdrawn (or deducted) a sum sufficient to restore the adjusted cost basis, and the amount (if any) _which thereaft er remains constitutes t he sain. The "amount realized" may be in cash or in other for m, such as a benefit to the seller, or an obligatio n of the seller is assumed or satisfied, or other property other than cash is transferred to or for the benefit of the seller. (Mertens,~., Sec. 1001:3, Vol. II, Ch. l, Subch. 0-Page 8~ under l inin9 ours.) The "amount realized" from the dispositio.n of property is the sum of any money plus the fair market value of property (other than money) received. (Sec. 1011:2 , Mertens, Ibid., Code Commentary, Vol. II, Ch. l, Subch. 0-Page 7.) Under the aforesaid Section 1002, it provides the general rule for requiring the recognition of the entire amount of gain or loss upon the sale or ex- change of property (Mertens, Ibid., Vol. II, Ch. L. 24 0

DECISION - CTA CASE NO. 2607 - 23 - Sub . 0-Page 11) and that the bas is of property shall be its "cost." (Sec. 101 2:1, Ib i d. , Page 13.) In order to determi ne the gain or loss i n sales or ex- changes of property, one must fir st know the cost basis of the property given in exchange, which must first be recovered or eliminated fr om the cost of the property rece ived in exchan~e , so as to iso l ate the profit or gain which is to be taxed. The cost ordinarily is not on ly t he pr i ce pa id for the property, but includes expenses involved in its acquisition, and capital expenses i ncurred on the property made ther eafter . (Section 1012:2, Mertens, Ibid., Vol. II, Ch. 1, Subch. 0-Page 14.) The purchase price of pro- perty includes any indebtedness to which it is ac- quired. (Ibid. ) The general scheme adopt~d by the law in deter- mining gain or loss is to first fi x the cost of the property given a t a generic "unadjusted" basis, ex- cept only in such instances where cost could not be the legal basis such as when the property was ac- quired before March 1, 1913, in which case the fair market value as of that date is taken as basis (Mertens, Law of Federal Income Taxation, Sec. 21.01, Vol. 3, 1942 Ed., pp. 356-357; Sec. 35(a) National In ter nal Revenue Code , as amended.) .or t he fai r market value at the time o f acquisition, if the said property .~ 2 :1... 1

DECISION - CTA CASE NO. 2607 - 24 - was acquired after March 1, 1913 by gratuitous title, i.e., by inheritance, donation or gift. But this unadjusted cost basis must always have to be adjusted, if any, by the increase or decrease due to expendi- tures, repayments, depreciation, obsolescence, amor - tization and depletion~ receipts~ losses, or other i tems. (Mertens, Law of Federal Income Taxation, 1954-58 Code) _195 9 Ed., pp. 420-421~ .l�.i9.., Vol. 3, 1942 Ed., p. 360.) Ordinarily, the original cost of property is ~eadily determinable and usually is the price paid for i t (in cash or other property)~ plus the cost of acquiring it, with appropriate ad- justments as aforesaid for capital expenditures, re- payments, or other equivalents. (Ib id., Vol. 3, 1942 Ed., p. 360.) That being the law, it is first important to know whether the properties that were transferred by the petitioner Nelly Magallanes Lopez and her late husband to MACDEN were properly costed. The properties transferred by petitioner to MACDEN had a total net book value, after allowing depreciation of the same, of ~429,988.85. These were the properties that were exchanged with secu- rities and other intangible assets such as shares of stocks with a value of ~1 20,000.00~ assumption � 2 4. ') /v

DECISION - CTA CASE NO. 2607 - 25 - by MACDEN of the outstanding financial obligations and liabilities of petitioner in the total amount of P297,114.10; and the receipt fro m MACDEN of the sum of Pl2,8 74.74 which is the remaining balance of the consideration of the transfer of said proper- ties in the amount of fl429,988.85. Under the Deed of Sale with Assumption of Obligations, the exchange was consummated on January 16, 1963. The properties transferred consisted of four (4) _par cels of land, with the buildings and improvements together with tractors, delivery and farm equipments, tools and implements, livestock~ service cars and other improve- ments thereon (Exh. 1, pp. 2-4, BIR rec.) ~ in con- sideration of the aforesaid application of Pl20,000.00 in payment of the unpaid subscriptions of petitioner to shares of stock of MACDEN; the assumption by MACDEN of the liabilities of petitioner in the total sum of fl297,114.10 appearing in petitioner's books, which includes accounts with the Philippine National Bank by way of crop loan, time and palay loans; and that the balance of Pl2,874.75 which shall be payable by MACDEN. As per books of petitioner, the schedule of assets and their costs sold to MACDEN Enterprise Co., Inc. less depreciations, for emphasis, is shown below: 24 ~

DECISION - CTA CASE NO. 2607 - 26 - SCHEDULE OF ASSETS SOLD 'lD AND LIABILITIES ASSUMED BY MACDEN ENTERPRISES CO. , INC. FROM MR . & MRS. CARLOS T. LOPEZ ASSETS C0 S T RESERVE FOR DEPRECIATION BC:OK VALUE Buildings & Laborers P68,703.09 P22,281.04 P46,422.05 Quarters 71,827.32 62,338.64 9,488.68 Tractors & Accesso- 2,772.01 2,772.01 16,881.38 ries 30,288.89 13, 407.51 1,684.63 Roads, Bridges & 3,851.37 2,166.74 76.84 Culverts 3,851.37 Delivery Equiprnents 3,221.43 519.38 Other Form Equipments 6,294.40 24,166.00 Farm Tools & Imple- 30,880.00 5,775.02 3, 027.00 3,027.00 6,714.00 ments Office Furniture & Fixtures Service Car Livestocks TOTAL P220,L942. 35 Eill8t676.39 Pl02l265.96 Agricultural Land - Hda. Los Angeles 240,000.00 Urban Lots 17,152.89 Residential Building 70t570.85 TOTAL ASSETS P429,988.85 In this instant case, there is no gain that has resulted in the exchange. What respondent did, how- ever, which gave rise to the gain subjected to tax was to appreciate the market value of the assets of petitioner, which has a book value of ~429,988.85 as shown above, and gave it a value at fair market at P964,738.37, apparently based on the report of Examiner Isabelo J. Romualdo (Exh. 3, pp. 12-14, BIR rec.) after his investigation, as foliows: 0 il , .t.. L. '~

DECISION - CTA CASE NO. 2607 - 27 - Kind of Property Fair Market Value 1. Residential Lots - - - - - -~ 62,475.00 2. Agricultural Lots - - - - - - - 47 1,553.00 3. Sugar Quota - - - - - - - - 229,779.30 4. 1962-1963 Standing Crop - - - - 149,561.07 5. Improvement in the Hacienda 51,37 0.00 T0 TAL - - - - - - - -~964 , 738.37 By this appreciation of the value of the properties sold to, or otherwise disposed of by exchange with MACDEN, from their costs or net book va lu es to their fair market values, or from P429,988.85 to P964,738.37, the difference resulting from the appreciation of the value of the assets is considered as the taxable gain. This approach used by respondent to determine the gain for ta.x purposes is due to the application of the case of Binalbagan Estate Inc. (G.R. No. L-12752, March 21, 1965), wherein it was stated that the in- crease in values of the assets over their costs should be taxed as profit realized from the exchange. It is to be noted, however, that with the in- crease in the value of the assets of petitiorer to P964,738.37, and if these fair market values shall be reckoned as their costs in the course of an ex- change, as in this case, and the properties received from such exchange represented by the payment of un- paid subscribed shares of stock of MACDEN of Pl20,000 .00 ; the satisfaction of the obligations in the value of P297,ll4.10; and the balance of Pl2,874.74 to be paid 24 5

DECISION - CTA CASE NO. 2607 - 28 - by MACDEN in installments, or in a total sum of ~429,988.85, which is much less in value than the alleged cost represented by the fair market value of P964,738.37, there is clearly a resultant loss rather than a taxable gain or profit that was real- ized, to which conclusion we agree with petitioner. But this is not so in this case since what wa s transferred or exchanged by petitioners were assets with costs or net books value of ~429,988.85 at the time of exchange, in consideration of or in return f o r the receipt of intangible property received with fair market value equal to the cost of the tangible and intang~ble properties and obligations given in exchange in the amount of P429,988.85. (See Exh. 1, pp. 2-4, BIR rec.) This being the case, the value of the properties given and the things received in exchange being the same, there is no gain or loss resulting from the exchange. Even granting that there was in fact appreciation of the value of the properties of petitioner given in exchange to P964,738.37, the appreciation of the values of properties given in exchange by itself will not give rise or bring about any gain or profit. (BIR Ruling No. 595, Series of 1959, Nov . 24, 1959; Scanlon vs. Comm., 42 BTA 997, cited in Jose Aranas, -9:1. ~' '

DECISION - CTA CASE NO. 2607 - 29 - National Internal Revenue Code, Vol. 3, p. 341.) In other words, the mere increase in value from their origianl net book value of P429,988.85 to their as- serted fair market value of P964,738.77, or an in- crease of P542,833.30, is not income but merely un- realized increase in value through the conversion of property which is not fundamentally taxable . (Mertens, Law of Federal Income Taxation, Vol. I, Par. 5.05; Fisher vs. Trinidad, 43 Phil. 943; Coll. of Int . Rev. vs. Adm. of the Estate of Exharri, 67 Phil. 502.} In the instant case, however, respondent, pluck- ing out a _statement in the aforesaid resolution of the Supreme Court in the Binalbagan ~ase, asserted that the properties of petitioner Nelly Magallanes Lopez which had an acquisition costs or net book value of P429,988.85, and which had been exchanged with the tangible and intangible personal properties, had appreciably increased to the fair market value of P964,738.37 at the time of exchange, and, hence, the difference arising from this appreciation of the value of the properties from their net book values of P429,988.85 to their alleged fair market value of P964,738.37 is the profit realized in the exchange. This approach cannot, to our mind, be legally '24 7

DECISION - CTA CASE NO. 2607 - 30 - acceptable inasmuch as in the disposition made by petitioner, thru the aforesaid Deed of Sale with Assumption of Obligation of her properties, res- pondent took into account the fair market value of the properties and not their costs, because this deed of sale is not, by its terms and contents substantially a sale. The transaction between peti- tioner and her husband, and MACDEN, to our mind is more in the nature of an exchange of property with unpaid shares, etc. rather than as sale of property. (See T. B. Noble, 12 BTA 1432, 1433; Burge, 14 BTA 733; Weiss vs. Stearn, 265 US 242.) And in the .exchanges of property, the "cost" of the property given is taken into account, and in the case of the property received,therefrom, in exchange, its fair market value is considered to determine whether in the transaction, there is gain or loss realized in the exchange. Under American and local authorities, the fair market value of property is not the same as the "cost" of the properties given in exchange, or in consideration for the satisfaction of obligations, the payment of the unpaid subscription and issuance of the corresponding shares of stocks, which are to be valued at "fair market value" in order to deter- mine whether there will be a gain realized in the '24 s

DECISION - CTA CASE NO. 2607 - 31 - exchange. The cost is not only the price paid for such property but include other costs, less or decreased by depreciation, absolescence, amortiza- tion and others. The fair market value is used only to value property received in the case of the ex- changes of property. In other words, " fair market value" is never used as value of. the property given in an exchange, except only where the property was acquired before March 1, 1913, or where the proper- ties were acquired by gratuitous title, in which case the fair market value is the basis. As against the books of petitioner, respondent not having shown that the properties of petitioner and her late hus- band exchanged were acquired by gratuitous title after March 1, 1913, or acquired prior thereto, the cost as shown in the books of accounts of petitioner prevails. Much more, as aforesaid, the mere appre- ciation or increase in value of the property in the exchange ther e of is legally and fundamentally not income for tax purposes and is only an unrealized increase in its value. (Mertens, Law of Federal In- come Taxation, Vol. I, par. 5.05; Fisher vs. Trinidad, of Exharri, 67 Phil. 502; Jose Ar anas, Nutional In- ternal Revenue Code, Vol. I, 1969 Ed., p. 341.) In . 2 4 !)

DECISION - CTA CASE NO. 2607 - 32 - this instant case, the value of the consideration received as a result of the exchange of the proper- ties given by petitioner, i.e., the credit of ~120,000.00 in return for the issuance of the unpaid ~ffiCDEN shares; the amount of ~297,114.10 assumed by MACDEN of the petitioner's PNB obligations; and the account receivable in the sum of.~l2,874.75, or the total of ~429,988.85, should properly be considered as their fair market value. The respondent did not quite understood the significance of the resolution in the case of Binal- bagan Estate Inc. case, which we think is inapplic- able to this instant case. The reason for the in- applicability of the Binalbagan Estate Inc. case, contrary to what has been asserted by respondent, is that the appreciation of value from the original cost, which is ~429,988.85 or an appreciable increase in value from said amount to its fair market value of ~964,738.37, in the amount of ~542,133.30, does not constitute the taxable gain realized from the exchange aforesaid because the mere increase in value of the properties in question did not bring about a realized gain in the exchange. In the de cision 1n the case of Binalbagan Estate, Inc., it is actually in the sell of the BISCOM shares 2 ~) 0

........ . DECISION - CTA CASE NO. 2607 - 33 - of stock, acquired thru exchange by Binalbagan Es- tate, Inc., to the Philippine Planters Corporation, that has brought about the gain on that transaction. Prior thereto, the exchange of the properties and sugar quota of Binalbagan Estate, Inc. with the BISCOM shares was consumated with. the said proper- ties and sugar quota casted at fair market value of P4,023,763.97, instead of the book value of P824,559.91, excepted in the latter case, the sugar quota, which the Supreme Court did not clearly be- licve to be the real acquisition cost, and, hence, held that the acquisition cost of the 216,000 stocks are of the same fair market value, or P4,023,763.97. So that when the non-par value BISCOM shares of stock were later sold at P6,192,935.00, there resulted a taxable gain. This was the factual situation in the Binalbagan Estate, Inc. case which is not the same as in the case at bar, or even analogous to it. In this instant case, the properties and assets of petitioner were exchanged with the stocks of MACDEN, and the assumption by the latter of petitioner's obli- gations. It is in the subsequent sale of the MACDEN non-par value shares of stocks, at their fair market

.. DECISION - CTA CASE NO. 2607 - 34 - value, which shall be the basis of the determin- ation of the gain or loss. There is no subsequent sale made of the MACDEN stocks received by peti- tioner Nelly Magallanes Lopez so as to come within the holding in the case of the Binalbagan Estate, Inc . The basis for determining gain or loss in ex- changes of property will be th~ difference in the acquisition cost or the latest inventory value of property given in exchange , and the fair: market value of the property received in exchange . (Call . of Int . Rev . vs. Binalbagan Estate, Inc., G.R. No. L-12752, Jan. 30, 1965, citing Sec. 35(c) _of the Nat. Int. Rev. Code,� and Sec. 136, Rev. Reg. No. 2 , Income Tax Regulation.) Considering that the asserted fair market value of the assets and properties (~964,738 . 37) which were given by petitioner in exchange of the tangible and intangible benefits received is higher in value than the properties received in exchange (~422,625.07) ~ there was no gain but instead there may be even a resultant loss to petitioner. It has been apparently asserted and \vrongly by respondent that the properties of petitioner, with a fair market value of ~964,738.37 , were exchanged only with the ~,600 shares of stocks of MACDEN . We think this is an error since what were really exchanged for the transfer of the 2 t':' ' ) . ,} l'v I I

.. DECISION - CTA CASE NO. 2607 - 35 - properties of petitioner to MACDEN were not only the: unpaid MACDEN shares of stocks, but also the assumption of the obligation of petitioner with the PNB by MACDEN in the sum of ~297,114.10; and the amount of ~12,674.75, which is the balance of the consideration of the transfer � of petitione~'s properties payable by MACDEN from date of execution of the deed of sale with assumption of obligation, with a total fair market value of ~429,988.85. The entering into a sale with assumption of obligation between petitioner and MACDEN, we believe is substantially more in the nature of an exchange rather than a sale. (Jacob Mertens, Law of Federal Income Taxation, Vol. 3A, Par. 22.92, citing Conrad Hilton, 13 TC 623; Sidney Weisner, TC ~1EMO 1961-234, etc.; Weiss vs. Loni Stearn, 265 US 241, 242, 68 ed ., 1001.) . A sale of property generally occurs where there is a disposition of property for cash, its equivalent, or the recipient's promise to pay. (Tauling v. US, 61-1, USTC, Par. 918.) ~cited in Mertens, Law of Federal Income Taxation, Vol. 3B par. 22-92) ~and an exchange of property ordinarily

DECISION - CTA CASE NO� 2607 - 36 - implies reciprocal transfers of as s ets other than cash, its equivalent, or the recipient's p r omise to pay (Ibid., citing Helvering vs. Autlian Flaccus Oak Leather Co., 313 US 247, 85 Led. 1310.) An ex- change is both a disposition of property transferred by a taxpayer and an acquisition of property received in return. (Ibid., citing Miller .vs . U.S., 331 F2d 8 54.) When a property is exchanged for another property, the property received in exchange shall, for the purpose of determining gain or loss, be treated as equivalent to cash, or the amount of its fair market value, if any. (Section 204(b) _of the u.s. Rev. Act of 1918, cited in A.V. Siegel et al., 14 US 186, 187.) Consequently, with the properties of peti- tioner that were exchanged being with a net book value or cost of ~429,988.85 and fair market value of ~964,738.37, with tangible and intangible assets (overpaid shares of stocks of IVlACDEN and assumed obligations)~ with a fair market value of ~429,988.85, no gain resulted from such e xchange therefor. IN VIEW OF THE FOREGOING, we are of the opinion and so hold that, the re be ing no gain r e sulting from the exchange thru the De e d of Sal e with Assumption of Obligation e nter e d into by and be twe e n pet i tione r 2. rt..'.f ..�j

DECISION - CTA CASE NO. 2607 - 37 - Nelly Magallanes Lopez and MACDEN, petitioner is not liable for deficiency income tax assessment in the amount of ~250,965.94 for 1963. The assessment issued against petitioner is, therefore, hereby set as ide. No pronouncement as to costs. SO ORDERED . Quezon City, Ap ril 21, 1982. CO~AN~E . ROAQU IN /ssoc1ate Judge WE CONCUR: ~tfpv Presiding Judge ~~~ Associate Judge