CTA Case No. 738 (Decision)

JOSE P. - DE LEON,� CECILIO P. DE C.I.A. LEOO, and ALBINA DE LEOO LIPANA, CASE NO. 738 heirs of the Intestate Estate of the late Dr. Felix de Leon, Petitioners , - versus - THE COW~ISSIQ~ER , Bureau of Internal Revenue , and the PROVINCIAL REVENUE OFFICER, Regional District No . 4, Respondents. DECI S I 0 N This is an appeal from a decision of the respon- . dent Commissioner of Internal Revenue dated December 8 , 1959 , assessing against and demanding from the peti- tioners, corporate income taxes for the years 1956 and 1957 , in the amounts oi � 7 , 832. 00 and ~9 , 495.00 , res - pectively , totalling ~17 , 327 . 00 , inclusive of the 25% surcharge , on the ground that with their failure up to the present time to partition among themselves real pro- perties inherited from their father since 1940, they ipso fa c to f ormed an unregistered partnership, and there- fore considered a corporation for income tax purposes , pursuant to Sections 24 and 84 (b) of the Tax Code. (Exh. R, pp . 60- 61 , BIR rec ., Folder No. 1.) The facts of the case as appearing in the ~stipu lation of Facts11 ( pp . 17-24 , CIA rec.) submitted by the parties , hereinafter to be referred to as STIFACTS for short , are not complex consisting mainly of documentary evidence .

DECISICN - C. I.A. CASE NO. 738 - 2- .. Here is a brief summary of the pertinent facts � The three petitioners herein are the acknowledged � natural children and legal heirs of the deceased Dr. Felix de Leon , who died intestate in the year 1940 leaving real properties including ricelands in the pro- , vinces of Bulacan and Nueva Ecija (par. 1 , STIFACTS p. 17 CIA rec . ; p. 126 CIA rec . ) . After the death of Dr. de Leon , intestate Special Proceedings No . 58390 was initiated in the Court of Fi~st Instanc e of Manila and with the view to expediting the final distribution of the estate , a c ompromise agreement (Exh. B, pp. ��41- 47 ,. CIA rec. ) was entered into by the petitioners herein on one side .and the surviving, legitimate and childl e ss spouse , Asuncion Soriano, on the other. It was stipu - lated in said compromise agreement, among others , that the petitioners would give a life annuity of 1,600 ca- vanes of palay to the surviving spouse , Asunc ion Soriano (pars. 2 & 3, STIFACTS) . The agreed life annuity in favor of the surviving spouse which was a joint and solidary obligation of the herein petitioners , was annotated as first lien on all the agricultural lands left by the deceased in the muni- cipality of San Miguel , Bulacan (par . 3 , STIFACTS) . In view of this subsisting joint and solidary obligation of the petitioners in favor of the surviving spouse, the petitioners agreed among themselves to keep in co- owner- ship , in equal shares , all the properties which the y .had I? )

DECISIQ~ - C.I . A. CASE NO. 738 ... 3 - inherited from their deceased father. (par. 4,. sri- FACTS.) The intestate estate proceedings of the de- ceased Dr. de Leon was closed on August 2, 1954. (par. 5 , STIFACTS.) Subsequently, the surviving spouse had to file in court civil actions (Civil Cases Nos. 135 and 488, C.F.I. Bulacan) against the petitioners for failure on their part to deliver in full during the years 1943 to 1952, inclusive, the quantity of palay provided in their compromise agreement. (par . 6, STIFACTS; pp. 126-138 CIA -record. ) The Court of First Instance of Bulacan , in a decision which was affirmed by the Supreme Court (G.R. No . L-7648) , ordered the petitioners ~n said cases to pay the surviving spouse, Asuncion Soriano, the amount of ~60,550.00, corresponding to the price of palay which they failed to deliver from 1947 to 1952, plus interest and attorney's fees. (par. 7, STIFACTS.) The agricultural properties inherited by the peti- tioners were sol~ at public auction to satisfy the judg- ment 'of the court in favor of Asuncion Soriano. (par. 8, STIFACTS.) However , said agricultural properties were la er redeemed by the petitioners upon payment of the sum of ~97 , 500.00, which redeemption price was raised by them by selling one of their commercial properties located at Magdalena St ., Manila> which they had inherited from their father. (pars. 9 & 10, STIFACTS.) Sometime in the year 1947 , the petitioners-heirs

DECISIQ\1 - C.I.A. CASE NO. 738 - 4- Jose P. de Leon and Cecilio P. de Leon , as joint ad- ministrators of the properties of the late Dr. de Leon , entered into a contract of lease with Messrs . Rivero y1 and Pascual wherein the latter as lessees, agreed to construct a three-story semi-concrete building on a vacant lot belonging to the estate located at ~ezon Boulevard , Manila , subject to the condition that upon the termination of the lease , the building and all the improvements thereon, shall become the exclusive and absolute property of the herein petitioners, without any obligation to refund to the lessees whatever ex- penses they may have incurred. (par. 11, SfiFACTS . ) The contract of lease was transferred by the original lessees to Cesar Ledesma, Inc., and upon the termina - tion of the lease on June 30, 1954, the herein peti- tioners became the absolute owners of said building, which has come to be known as the �1f . de Leon Building". (par. 12, STIFACTS.) It appears that the income derived from all the properties inherited by the petitioners, as well as the expenses of administration, are borne equally by them , share and share alike, and each petitioner reported in their individual income tax returns for the years 1956 and 1957, their corresponding share of the income and expenses. (par. 13, STIFACrs; Exhs. K, K-1 , L and L- 2, pp. 111-122 CIA rec.) During all these years since the death of their father in 1940, the petitioners while I

DECISION - C.T.A. CASE NO. 738 - 5- administering the inherited properties, never contri- \~ buted money to a common fund. Neither did they engage in real estate or any other business for profit using the inherited properties as capital, with a view to expand1ng or increasing their family holdings. On the contrary, because of their failure to comply in full with the life annuity agreed upon in favor of their co-heir , Asuncion Soriano, who is still living, they were hailed to court and forced to sell one of the in- herited properties consisting of a commercial building located at Magdalena St. in Manila. All these circumstances notwithstanding, the res- pondent, after due investigation ruled that the co- ownership of the petitioners is an unregistered part- nership , and therefore taxable as a corporation under Sections 24 and 84 (b) of the Tax Code. Thus, the res-v pendent issued the disputed assessments for corporate income taxes against the petitioners for the years 1956 and 1957 which are now the subject of this appeal. The only issue to be decided in this case is whe- ther or not under the circumstances stated above, the co-ownership of the petitioners over the properties in- herited from their father , may be considered an unregis- tered partnership, hence, taxable as a corporation for income tax purposes under Sections 24 and 84 (b) of the National Internal Revenue Code. For income tax purposes, Section 84 (b) of the Tax Code defines a corporation as follows:

DECISIO'J - C.I.A. CASE NO. 738 - 6- usee. 84. When used in this Title X X X X (b) The term 1 corporationt includes partnerships, no matter how created or or- ganiz e d. joint-s t~oc k companies, jo i nt count s { cuentas p articipacio n), as s ac~ - ocia tions or insurance c omp_anies, but does not include duly registered general copartner- ships (compafiias colectivas). n And Section 24 of the same Code, in prescribing the rate of corporate income tax, states in part as follows: ��sec. 24. Rate of tax on corporation.s.- (A) In general, there shall be levied, as- sessed, collected, and paid annually upon the total net income received in the preced- ing taxable year from all sources by every corporation organized in, or existing under the laws of the Philippines, no matter how created or organized, but not including duly registered general copartnerships {compafiias colectivas), domestic life insurance com- panies and foreign life insurance companies doing business in the Philippines, a tax upon such income equal to the sum of the following: x x x" Pursuant to the above quoted provisions of the National Internal Revenue Code, the respondent Commis- sioner of Internal Revenue, in deciding the protests /j of the petitioners against the disputed assessments in question, has adhered to the strict and steadfast rule that "properties held by co-heirs which are income pro- clueing or profit earning, except those belonging to duly registered co-partnerships, x x x shall be considered as owned by unregistered partnerships and the income derived therefrom shall be subject to the payment of corporate income taxes1'. (Exh. R, pp. 60-61, BIB. rec., Folder No. 1) On the basis of said ruling, the respondent con-

DEGISIO."J - C.I.A. CASE NO. 738 - 7- cluded 7 and now insists that the petitioners herein are subject to the tax on corporations at the rate of 207~ of the net income not exceeding i=lOO, ()(X). 00 (Sec - tion 24 National Internal Revenue Code). We believe that the interpretation given by the respondent to the term "corporation" as defined in Section 84 (b) of the Tax Code as to embrace without exception all possible co- ownerships over inherited properties which are income producing is much too unreasonable and stringent. Go-heirs who own proper- ties which produce income should not automatically be considered partners of an unregistered partnership, or a corporation, within the purview of the income tax law. To hold otherwise, would be to subject the income of all co-ownerships of i nherited properties to the ax on corporations, inasmuch as if a property does not pro- duce any income at all , it is not subject to any kind of income tax, whether the income tax on individuals or the income tax on corporations. In short and in effect, to adopt the view of the Commissioner of Internal Re- venue, would be tantamount to declaring that all co- ownerships, whether by co- heirs or not, are unregistered partnerships which in .some particular instances might lead to unfair consequences. Certainly, the word "co- ownership" has a separate and distinct meaning from the term 0 partnershipa.

� DECISION - C.I.A. CASE NO. 738 - 8- And moreover , to rule that properties held by co-heirs which are income producing should be consi- dered as owned by unregistered partnerships is con- trary to the plain and clear provisions' of Article 1769 of the Mew Civil Code which states in part that nco- ownership X X X does not of itself establish a partnership 1 whether such co- owners x x x do or do not share any profits made by the use of property�� and that the "sharing of gross returns does not of itself' esta- blish a partnership , whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived." As explained by Mr . Justice Felix Angelo Bautista , in his concurring opinion in the case of Evangelista vs . Collector of I nternal Revenue 1 G.R. No . L- 9996 , October 15, 1957 , (54 O. G. 996, 1003) "the fact that those who agree to form a co- ownership share or do not share any profits made by the use of the property held in c ommon does not convert their venture into a part - nership . Or the sharing of the gross returns does not of itself establish� a partnership whether or not the persons sharing therein have a joint or common right or interest in the property.~ Furthermore , as far as we know , there is no law that requires heirs or c o- owners of inherited ~proper ties without anyone of them asking for it or without any agreement to the c ontrary (Artic le 494 New Civil I

DECISICN - C. I.A . CASE NO. 738 - 9- Code) to partition among themselves within a spec ified period of time the properties acquired by inheritance or held in co" ownership . Article 494 of the New Civil Code must have fore seen the impossibility or imprac - ticability of immediate partition in some instances to the extent that it allows co- ownership to exist by agree- ment for a period not exceeding ten (10) years subject to extension by a new agreement. The same article gives donors or testators the right to prohibit partition for a period which shall not exceed twenty (20) years . If we were now to give sanction to the theory of respondent that ~ co- ownerships , whether by c o- heirs or not , are unregistered partnerships and therefore subject to an addi- tional income ta x burden , we would in effect render with- out meaning and much too burdensome for co- owners , donors and testators to avail themselves of the rights accorded them under the aforesaid article of the New Civil Code , irrespective of whether or not their intention to con- tinue with the c o- ownership is just for the purpose of rehabilitating , maintaining and preserving what they al- ready own in common or for business and further expansion . As is the situation in the instant case, it ap- pears that during the years now in review (1956 and 1957), the petitioners have reported in their individual income tax returns and paid the corresponding inc ome tax tlrereon on their share of income derived from the inherited pro- perties . (par . 13 t STIFACTS , p . 21 erA rec . ; Exhs . K, I j

DECISION - ~tr.A. CASE NO. 738 - 10 - K- 1, Land L- 1 , pp . 111- 122 CTA rec.) Respondent now insists that the estate should lil'ewise pay corporate income taxes for the same years in the total sum of i!l7,327 . 00 as an unregistered partnership . While it is true that the definition of the term ~corporationn as given in Section 84 (b) of our Tax Code is � broader in scope and far more embracing than the y ordinary definition of a corporation found in Section ... 2 of � ~�~ �.Ac t No. 1459, otherwise known as the Corpora - ; tion Law- we still believe and so hold that on grounds of fairness and equity, the respondent should not apply the broader definition of the Tax Code indiscriminately so as to embrace within the definition all classes of co-ownerships irrespective of the underlying reason or reasons for their creation and existence/( Undoubtedly , if the sole purpose of the co-heirs for maintaining in perpetuity their co- owner s hip over the inherited estate is to see it expand be~~n~imit _ by embarking in all I kinds of bu siness ventures , then the application of said . sections of the Tax Code and the ruling of the Supreme Court in Eufemia Evan�elista, et al. vs . The Collector of Internal Revenue, et al. supra, would be in order. However, there are instances when co-owner- ship over inherited properties is kept at status guo for years through no liking of the co-own ers or co- heirs but made so by some legal impediment as in he instant case where the petitioners jointly and soli- darily agreed to give a life a nuity of 1, 600 cavanes

DECISION - C.I.A. C SE NO. 738 ~ 11 - of palay produced from their inherited hacienda in San Miguel , Bulac an , to their co-heir, Asuncion S orian~ .who is still living at present. I To cit e other spec ific instances. There are heirs who choose ot to partition the estate left by their parents not for financial aggrandizement but for purely sentimental reasons and to maintain as closely knit as possible their family ties after the death of their ascendants. The family is a basic so- cial institution which public policy cherishes and pro- tects (Art . 216 New Civil Code). other.s do so for practical reasons believing that With the estate left undivided, particularly small estates with numerous heirs, the expenses of administration could be consi- derably minimized/and the obtaining of credit facili- ties for operational ~xpenses made easier. Others find it simply- impossible physically and legally -- to partition , much as they would want to, as is the case of numerous heirs inheriting an estate co0sisting let us say of just one commercial building or an ancestral home being leased to a third �party where none of the heir s is willing to sell his undivided share to his other co-heirs or to outsiders. :t1Lex non intendit aliquid impossibile.fl Under Article 10 of the New Civil Code , i n case of doubt in , the interpretation or application of laws, it is presumed that the lawmaking body intended right and justice to prevail. I

r DECISIO\J - C.I.A. CASE NO. 738 - 12 - In his memorandum ~ (pp. 169-173 CTA rec.) the respondent has made much capital of the fact that some- time in 1954 , during the existence of petitioners' co- ownership, they were able to acquire a semi- concrete commercial building at ~ezon Blvd ., Manila from which they have been deriving substantial rentals. As here - tofore stated , the petitioners inherited from their father among other properties , a vacant lot located at ~uezon Blvd ., Manila. In 1947 , they entered into a con - tract of lease Exhibit I (pp. 10- 14 Folder No. 1) with Messrs. Rivero and Pascual wherein the latter, as lessees, agreed at their expense to construct a three- story semi- concrete building on the vacant lot subject to the condition that upon the termination of the lease, the building and all the improvements thereon shall be- come the exclusive and absolute property of the peti- tioners , without any obligation to refund to the lessees whatever expenses they may have incurred (par. 11, sri- FACTS, p . 20 CIA rec.). The contract of lease was trans - ferred by the original lessees to Cesar Ledesma , Inc ., and upon the termination of said contract on June 30, 1954 , the petitioners herein became the absolute owners of said building, which has come to be known as the 11 F. de Leon Building" (par. 12, STIFACIS, pp . 20-21CTArec . ). Respondent maintains that the share of each of the present petitioners in said building , for all in- tents and purposes , is their contribution to a comnon fund, an additional asset which did not exist at the time of their father ' s death in 1940 nor formed part of the j

r DECISICN - C.T.A. CSSE NO. 738 - 13 - decedentts estate. In short 1 the respondent concludes that the petitioners did engage in the real estate business and were able to expand their family interests while holding the inherited properties under the concept of co-ownership, and therefore, liable for the addi- tional income tax demanded as an unregistered partner- ship following the doctrine laid down in the Evangelista case. (Respondent�� s Memorandum, pp. 171-172 CTA rec.) It is of common knowledge, and this Court takes judicial notice of the fact, that before the last world war, as is the case at pres~nt, there were many families, particularly in populated areas like Manila, whose main source of income was derived from house rentals. As a result of the ravages of the last war, many heads of families perished leaving to their heirs after the libe- ration, nothing but empty lots where once stood commer- cial buildings, residential and apartment houses. In many cases, the heirs of these vacant lots who were left practically destitute after the liberation, chose not to partition post-hastedly believing and with good reason, that with their co~non properties and joint efforts; the war damage payments from the United States; and,. other credit facilities extended the war victims by our Govern- ment such as those granted by the defunct Rehabilitation Finance Corporation, they would in the course of time replace their lost properties and make them income pro- ducing once again before partitioning the estate among /( j J

f DECISION - C. I . A. CASE NO. 738 - 14 - themselves . If we sustain now the inflexible theory of the respondent , by holding that these estates should have been partitioned immediately after the liberation to free the heirs from an additional income tax burden as an unregistered partnerships, thereby leaving each heir to shift for himself , we would be adding many more � years before the complete rehabilitation of our country is attained. The ruling of the Supreme Court in the-~vangel�sta case , supra , relied upon by respondent is not applicable to the present case , because the two cases are based on an entirely differen~ set of facts. The differences: 1 . In the Evangelista case , the "common fund was not something they found already in existence. It was not a property inherited by them pro indiviso. They created it purposely . \Jhat is more , they jointly bor- rowed a substantial portion thereof in order to esta- blish said common fund. �11 In the instant case , the COi!1- ~on fund was already in ~xistence when the petitioners be came th~ co-owners of th same . They did not create the fund but merely inherited the same from .t heir father . The petitioners herein never borrowed money in order to establish or to add to the common fund; 2. In the Evangelista case , the taxpayers therein "invested the same , (i.e ., the common fund), not merely in one transaction , but in a series of transactions. x x x The number of lots (24) acquired and transactions

DECISION - C.I.A. CASE NO. 738 - 15 - undertaken, as well as the brief interregnum between each, particularly the last three purchases , is strongly indicative of a pattern or common design that was not limited to the conservation and preservation of the afore- mentioned common fund. 11 In the case under consideration, all the actions of the petitioners were .limited merely to the conser- vation and preservation of the inherited properties. They never contributed even a single centavo from their own pockets in order to invest the same. Nhatever they received from their late father was already invested. And instead of adding to their co- ownership , they sold some of their inherited properties; 3. In the Evangelista case~ the co- owners I against whom the disputed assessments for corporate income taxes were issued , were Eufemia , Manuela , and Francisca , all surnamed Evangelista , and ~the properties have been under the management of one person , namely , Simeon Evangelista, 11 who was not one of the co- owners . 11Thus the affairs relative to said properties have been handled as if the same be- longed to a corporation or business enterprisa operated for profit . v In the present case, the petitioners are not merely co- owners but co-heirs , and the properties which they inherited were joint ly managed by co- owneDs Jose P. de Leon and Cecilio P. de Leon , two of the three peti- tioners in this case; and, I

DECISION - C.I.A. CASE NO. 738 - 16 - 4 . In the Evangelista case, the taxpayers therein 11 have not testified or introduced any evidence, either on their purpose in creating the set up already adverted to, or on the causes of its continued existence. They did not even try to offer an explanation therefor. 11 In the case at bar, as stated above, the petitioners did not create the "set up''� It was created and established by the death of their father. And they explained to the satisfaction of this Court the cause for the continued existence of the co-ownership of the inherited properties, i.e ., the sub$isting Joint and solidary obligation of the petitioners to deliver annually 1,600 cavanes of palay to Asuncion Soriano during the latter 's life time, which from the records of the case, it appears that the peti- tioners are having a hard time to comply with� .� HEREFORE , in view of .the foregoing considerations, the decision of the respondent Commissioner of Internal ~evenue assessing against the petitioners corporate in- come taxes for the years 1956 and 1957, in the total amount of 17, 327. 00, is hereby reversed, without pro- nouncement SO ORDERED. Manila , September 11 , 1961 . E CONCUR: ROIIAN M. UMALI Associate Judge