Citibank, N.A. vs. Court of Appeals and Commissioner of Internal Revenue

Creditable withholding taxes withheld from rental income during the taxable year are provisional installments of the taxpayer's annual income tax liability; their correctness and legality are determined only upon filing the final adjustment return at the end of the taxable year, and where the taxpayer's final return shows net losses resulting in no income tax liability, such withheld taxes become erroneously collected and must be refunded to the taxpayer.

The dispute arose under the Expanded Withholding Tax Regulations (BIR Revenue Regulations No. 13-78), which mandated lessees to withhold five percent of rental payments to lessors as creditable withholding tax. Citibank, N.A. Philippine Branch, a foreign corporation doing business in the Philippines, had tenants withhold these taxes from rental payments in 1979 and 1980. After filing its annual income tax returns showing substantial net losses for both years—thus having no income tax liability—Citibank claimed refunds of the withheld amounts. The Commissioner of Internal Revenue contested the refund, arguing that the taxes were legally collected at the time of withholding pursuant to regulations and therefore were not "erroneously or illegally collected" under Section 230 of the Tax Code.

• Citibank, N.A. Philippine Branch is a foreign corporation licensed to do business in the Philippines.
• During taxable years 1979 and 1980, Citibank's tenants withheld and remitted to the Bureau of Internal Revenue five percent of rental payments pursuant to Section 1(c) of the Expanded Withholding Tax Regulations (BIR Revenue Regulations No. 13-78), totaling P270,160.56 for 1979 and P298,829.29 for 1980.
• On April 15, 1980, Citibank filed its 1979 corporate income tax return declaring a net loss of P74,854,916.00 and tax credits of P6,257,780.00, excluding the withheld rental taxes which were not utilized due to the net loss.
• On April 15, 1981, Citibank filed its 1980 corporate income tax return showing a net loss of P77,071,790.00 and available tax credits of P11,532,855.00, also excluding the withheld rental taxes.
• Citibank included the rental income as part of its gross income in both annual returns.
• The Commissioner of Internal Revenue did not allege any falsity in Citibank's income tax returns before the Court of Tax Appeals or the Court of Appeals, nor did he present any assessment of deficiency taxes against Citibank.

• The five percent withholding tax on rentals is a creditable withholding tax (not a final tax) that constitutes merely an advance or installment payment of the annual income tax liability, creditable against the tax due at year-end.
• The determination of whether the withholding tax was erroneously or illegally collected must be reckoned at the end of the taxable year upon filing the final adjustment return, not at the time of withholding.
• Because Citibank's final income tax returns for 1979 and 1980 demonstrated net losses and zero income tax liability, the withheld taxes became erroneously collected at year-end and are refundable under Section 230 of the National Internal Revenue Code.
• The Court of Appeals erred in requiring proof that the taxes were illegally collected at the time of withholding, ignoring the provisional nature of creditable withholding taxes and the yearly computation principle of income taxation.

• The withholding taxes were collected in strict accordance with Section 1(c) of Revenue Regulations No. 13-78, making the collection legal and valid at the time of withholding.
• Citibank bore the burden of proving that the taxes were illegally or erroneously collected, which it failed to discharge by merely showing net losses without proving the withholding itself was illegal.
• The legality of the withholding at the time of collection precludes characterization of the taxes as "erroneously or illegally collected" under Section 230 of the Tax Code, regardless of the taxpayer's ultimate tax liability.
• The claim for refund should be denied because the withholding agents (tenants) complied with their statutory duty to withhold, and the taxes were properly remitted to the BIR as advance payments of income tax.

• Procedural Issues: Whether the claim for refund was seasonably filed within the two-year prescriptive period under Section 230 of the National Internal Revenue Code, and from what date the prescriptive period commences to run for creditable withholding taxes.
• Substantive Issues: (1) Whether creditable withholding taxes on rental income become "erroneously or illegally collected" when the lessor incurs net losses and has no income tax liability for the taxable year; and (2) Whether the determination of the illegality or error in the collection of creditable withholding tax should be reckoned at the time of withholding or at the end of the taxable year upon filing the final adjustment return.

• Procedural: The Supreme Court held that the two-year prescriptive period under Section 230 of the NIRC commences to run only from the time the refund is ascertained, which can only be determined after the filing of the final adjustment return, not from the dates of quarterly or periodic withholdings; thus, the claim filed on October 31, 1981, for taxes withheld in 1979-1980 was seasonably filed.
• Substantive: The Court ruled that creditable withholding taxes are provisional installments of the annual income tax liability, and their legality is determined only at year-end upon filing the final adjustment return; since Citibank's final returns showed net losses and no tax liability, the withheld taxes became erroneously collected and refundable under Section 230 of the NIRC and Article 2154 of the Civil Code (solutio indebiti), as the government cannot enrich itself at the taxpayer's expense by retaining taxes where no tax is due.

• Creditable Withholding Tax as Provisional Payment — Creditable withholding taxes are not final taxes but constitute mere advances or installments of the taxpayer's annual income tax liability, subject to adjustment upon determination of the correct tax liability after filing the final adjustment return at year-end.
• Final Adjustment Return Doctrine — The correctness of taxes paid during the year (whether quarterly income taxes or creditable withholding taxes) is determined only upon filing the final adjustment return at the end of the taxable year, and any excess shown on that return constitutes erroneously collected taxes refundable to the taxpayer.
• Solutio Indebiti — Under Article 2154 of the Civil Code, if something is received when there is no right to demand it, the obligation to return it arises; thus, the government must refund tax payments collected where the taxpayer ultimately has no tax liability.
• No Enrichment at Another's Expense — The government cannot retain tax payments that exceed the taxpayer's actual liability, as this would constitute unjust enrichment at the taxpayer's expense in violation of elementary principles of justice.

• "The withholding tax system was devised for two main reasons: first, to provide the taxpayer a convenient manner to meet his probable income tax liability; and second, to ensure the collection of the income tax which could otherwise be lost or substantially reduced through failure to file the corresponding returns."
• "The taxes thus withheld and remitted are provisional in nature."
• "Clearly the prescriptive period of two years should commence to run only from the time that the refund is ascertained, which can only be determined after a final adjustment return is accomplished."
• "Hence, under the principle of solutio indebiti provided in Art. 2154, Civil Code, the BIR received something when 'there [was] no right to demand it,' and thus 'the obligation to return arises.'"
• "Heavily militating against Respondent Commissioner is the ancient principle that no one, not even the state, shall enrich oneself at the expense of another."

• Commissioner of Internal Revenue v. Philippine American Life Insurance Co. — Cited for the principle that the two-year prescriptive period for tax refunds commences only from the filing of the final adjustment return, not from quarterly or periodic tax payments.
• Gibbs v. Commissioner of Internal Revenue — Cited for the doctrine that withheld taxes are in the nature of payment by a taxpayer to extinguish his possible tax obligation and are installments on the annual tax due.
• Commissioner of Internal Revenue v. TMX Sales, Inc. — Cited for the holding that quarterly income tax payments are mere installments of the annual tax due, to be adjusted at year-end, and that the final adjustment return truly reflects the results of operations.
• San Carlos Milling Co., Inc. v. Commissioner of Internal Revenue — Cited for the principle that the BIR must investigate and confirm claims for tax refund, and that the grant of a refund is founded on the assumption that the tax return is valid unless proven otherwise.
• Collector v. Antonio Prieto — Cited as precedent for the rule that income taxes remitted periodically should be credited or refunded based on the taxpayer's final adjusted returns.
• ACCRA Investments Corp. v. Court of Appeals — Cited for the principle regarding the determination of refundable amounts based on final adjustment returns.
• Madrigal v. Rafferty — Cited for the concept of income as a flow measured over an accounting period.
• Ramie Textiles, Inc. v. Mathay, Sr. — Cited for the application of solutio indebiti to tax refund cases where payments were made without underlying liability.

• Section 230, National Internal Revenue Code (formerly Section 292) — Governs recovery of tax erroneously or illegally collected and establishes the two-year prescriptive period for filing claims for refund.
• Section 69, National Internal Revenue Code — Provides for the filing of final adjustment returns and the refund or credit of excess quarterly tax payments, establishing that the refundable amount is that shown on the final adjustment return.
• Section 53(f), National Internal Revenue Code (now Section 50) — Authorizes the withholding of creditable tax at source on various items of income including rentals, allowing such withheld taxes to be credited against the income tax liability for the taxable year.
• Article 2154, Civil Code of the Philippines — Provides for solutio indebiti, creating an obligation to return something received when there is no right to demand it.
• Revenue Regulation No. 13-78, Section 1(c) — The Expanded Withholding Tax Regulations requiring 5% withholding on rental payments exceeding P500.00 as creditable withholding tax.