Commissioner of Internal Revenue vs. Court of Tax Appeals

A legislative franchise is presumed to be an operative act and its constitutionality will not be passed upon unless the resolution of the constitutional question is indispensable to the decision of the case. Furthermore, a special legislative franchise prevails over general statutes, and its tax exemption provisions are enforceable against the government agency tasked with tax collection.

Private respondent Eastern Extension Australasia and China Telegraph Co., Ltd. is a foreign corporation organized under the laws of Great Britain, engaged in international telecommunications. It was originally granted a concession by a Spanish Royal Decree in 1898 to construct and operate a submarine telegraph cable from Hong Kong to Manila. Upon the expiration of that concession, Congress enacted Republic Act No. 808 in 1952, granting the respondent a legislative franchise to operate the cable system, which was later amended by Republic Act No. 5002 in 1967 to enlarge its scope. Section 8 of Republic Act No. 808 granted the respondent an exemption from all municipal, provincial, and national taxes, except for a 5% franchise tax on gross earnings and real property taxes.

Private respondent Eastern Extension Australasia and China Telegraph Co., Ltd., a foreign corporation organized under British laws, was engaged in international telecommunications. It was originally granted a concession by a Spanish Royal Decree in 1898 for a submarine telegraph cable from Hong Kong to Manila. When this concession expired, Republic Act No. 808 was approved on June 21, 1952, granting the respondent a legislative franchise to land, construct, maintain, and operate the submarine cable. Section 8 of the Act required the respondent to pay a 5% franchise tax on gross earnings originating in the Philippines, in lieu of all other national, provincial, or municipal taxes, except real property tax. The franchise was later amended by Republic Act No. 5002 on May 2, 1967, to expand the scope of its operations. Pursuant to Section 8, the respondent regularly reported its gross Philippine earnings and paid the corresponding franchise tax to the General Auditing Office beginning in 1952.

The controversy began on November 25, 1971, when the petitioner Commissioner of Internal Revenue assessed the respondent P7,122,571.61, representing deficiency income tax, inclusive of surcharges, interests, and penalties for the years 1965 to 1970. The assessment was predicated on the belief that the respondent's franchise was inoperative for failing to comply with Section 8, Article XIV of the 1935 Constitution, which required public utilities to be at least 60% Filipino-owned. The respondent protested the assessment through letters in January 1972, arguing that the assessment lacked basis and that prescription had set in. The petitioner rejected this protest on February 28, 1973, and even expanded the assessment to cover the years 1952 to 1971, amounting to P21,523,288.37.

On March 13, 1973, the respondent filed a petition for review with the Court of Tax Appeals to contest the expanded assessment. Meanwhile, on July 24, 1974, Presidential Decree No. 489 was promulgated, authorizing the respondent to transfer its franchise to Eastern Telecommunications Philippines, Inc., a corporation organized under Philippine laws with at least 60% Filipino ownership. The respondent subsequently transferred the franchise. On February 18, 1976, the Court of Tax Appeals reversed the Commissioner's assessment, declaring the franchise unconstitutional but cancelling the assessment on the grounds of prescription and non-retroactivity of rulings. The Commissioner's motion for reconsideration was denied on June 18, 1976, prompting the present petition for review.

• Constitutionality as a Non-Issue: Petitioner argued that the constitutionality of Republic Act No. 808 was never raised as an issue by either party and was not necessary for the resolution of the case.
• Inoperativeness of Franchise: Petitioner maintained that the tax exemption provision in the franchise was unenforceable because the respondent failed to comply with the 1935 Constitution, the Corporation Law, and the Public Service Act, specifically failing to restructure its equity to 60% Filipino ownership, obtain a certificate of public convenience, and secure a license to do business.
• Grave Abuse of Discretion: Petitioner contended that the respondent court acted in excess of jurisdiction in declaring the assessment "fantastic and fabulous" without conducting a trial on the merits to examine the examiners' findings.
• Prescriptive Period: Petitioner argued that the assessment was issued within the ten-year prescriptive period under Section 332(a) of the Tax Code, as the respondent's failure to file income tax returns for twenty years was only discovered in 1971.
• Nature of Assessment: Petitioner asserted that the assessment was an ordinary assessment for deficiency income tax, not a ruling or revocation under Section 338-A of the Tax Code.

• Constitutionality as a Prejudicial Question: Respondent argued that the constitutionality of the legislative franchise was an indispensable issue and a prejudicial question properly raised during pre-trial, as it determined the validity of the tax exemption.
• Validity of Franchise and Tax Exemption: Respondent maintained that it had complied with all the terms and conditions of Republic Act No. 808, and that the franchise, as a special law, prevailed over general statutes like the Public Service Act and the Corporation Law. It further argued that it was prohibited by Section 15 of the franchise from transferring or restructuring its equity without Congressional approval.
• Prescription of Assessment: Respondent contended that the assessment was made beyond the prescribed period required by the Tax Code.
• Non-Retroactivity of Rulings: Respondent argued that the assessment was tantamount to a revocation of the franchise tax under Section 259 of the Tax Code and, therefore, could not be given retroactive effect pursuant to Section 338-A of the same code.

• Constitutionality of Franchise: Whether the constitutionality of the legislative franchise granted to the respondent should have been passed upon by the Court of Tax Appeals when it was not an issue raised in the pleadings.
• Enforceability of Tax Exemption: Whether the provision in the franchise requiring the payment of only 5% of gross receipts in lieu of any and all taxes is unenforceable and without effect, considering that the franchise is inoperative for failure of the respondent to comply with the requirements of the Constitution, the Corporation Law, and the Public Service Act.
• Jurisdiction and Grave Abuse: Whether the respondent court acted in excess of jurisdiction in declaring the assessment "fantastic and fabulous" considering that there had been no trial on the merits of this case.
• Prescriptive Period: Whether the assessment was issued within the period prescribed by law.
• Nature of Assessment: Whether the petitioner's assessment against the respondent is in the nature of a ruling within the purview of Section 338-A of the National Internal Revenue Code.

• Constitutionality of Franchise: No. The constitutional question was not necessary for the disposition of the case, and the Court must avoid deciding it by maintaining the presumption of constitutionality.
• Enforceability of Tax Exemption: No. The franchise is operative and enforceable, as a special legislative franchise prevails over general statutes, and the respondent could not restructure its equity due to the franchise's prohibition on transfer without Congressional approval.
• Jurisdiction and Grave Abuse: No. The phrase "fantastic and fabulous" is an obiter dictum and a collateral matter, and its inclusion does not constitute grave abuse of discretion amounting to lack of jurisdiction.
• Prescriptive Period: Yes. The assessment was issued within the ten-year prescriptive period under Section 332(a) of the Tax Code, as the omission was discovered in 1971 and the assessment was issued in 1973.
• Nature of Assessment: No. The assessment is an ordinary assessment for the payment of taxes, not a revocation, modification, or reversal of a ruling or regulation under Section 338-A of the Tax Code.

• Constitutionality of Franchise: The requisites for judicial inquiry into a constitutional question include the necessity that the constitutional question be passed upon in order to decide the case. Here, the case could be resolved based on other available grounds. The Court gives high respect to the acts of other government departments and avoids deciding constitutional questions when possible. Moreover, legislative deliberations indicated that Congress excluded international telecommunications operating merely a terminal in the Philippines from the constitutional prohibition on public utility franchises.
• Enforceability of Tax Exemption: A legislative franchise partakes of the nature of a contract, and the government is bound by its terms. Republic Act No. 808 is a special law applicable only to the respondent, prevailing over general statutes like the Public Service Act and the Corporation Law. The respondent duly complied with all franchise conditions. Furthermore, Section 15 of the Act expressly prohibited the respondent from transferring or assigning the franchise without Congressional approval. Presidential Decree No. 489, authorizing the transfer, was only issued in 1974. Thus, the respondent could not be faulted for failing to restructure its equity to meet the 60% Filipino ownership requirement earlier.
• Jurisdiction and Grave Abuse: Grave abuse of discretion requires a capricious and whimsical exercise of judgment equivalent to lack of jurisdiction, amounting to an evasion of positive duty. The phrase "fantastic and fabulous" was an obiter dictum, as the court did not proceed with the merits or deal with the factual issue of the assessment amount. Disregarding the phrase causes no substantial change to the decision, and thus does not amount to grave abuse of discretion.
• Prescriptive Period: Under Section 332(a) of the Tax Code, in the case of a failure to file a return, the tax may be assessed within ten years after the discovery of the omission. The respondent failed to file corporate income tax returns from 1952 to 1971, and the omission was discovered in 1971. The assessment issued on February 28, 1973, was well within the ten-year prescriptive period. However, because the franchise is operative, the respondent is exempt from income tax on earnings from its franchised operations. The assessment is only valid for income derived from services within the Philippines beyond the scope of Republic Act No. 808, such as managerial services and building rentals.
• Nature of Assessment: Section 338-A contemplates the revocation, modification, or reversal of rules, regulations, rulings, or circulars promulgated by the Commissioner, not the revocation of a provision of the Tax Code itself. The assessment was issued because the Commissioner believed the respondent was liable for corporate income tax due to an inoperative franchise, not to revoke Section 259 of the Tax Code. Therefore, it should be treated as an ordinary assessment for taxes due on income beyond the franchise's scope.

• Presumption of Constitutionality — A law is presumed to have been carefully studied and determined to be constitutional before its enactment. Courts must avoid deciding constitutional questions unless absolutely necessary for the disposition of the case, maintaining high respect for the acts of other government departments.
• Special Law vs. General Law — A special legislative franchise prevails over general statutes like the Public Service Act and the Corporation Law. The presumption is that special statutes are exemptions to the general law because they pertain to a special charter granted to meet particular conditions.
• Legislative Franchise as a Contract — A legislative franchise partakes of the nature of a contract between the sovereign power and the grantee. The government, including its agencies, is bound by the terms of the franchise, and tax exemptions granted therein serve as inducement for the acceptance of the franchise and rendition of public service.
• Prescriptive Period for Tax Assessment — Under Section 332(a) of the National Internal Revenue Code, if a taxpayer fails to file a return, the tax may be assessed within ten years after the discovery of the falsity, fraud, or omission.

• "It is a well-settled rule that no constitutional question will be heard and resolved unless the following requisites of a judicial inquiry are present: (1) the existence of an appropriate case; (2) an interest personal and substantial by the party raising the constitutional question; (3) the plea that the function be exercised at the earliest opportunity; and (4) the necessity that the constitutional question be passed upon in order to decide the case" — This passage establishes the four-part test for the exercise of judicial review on constitutional questions, emphasizing the necessity criterion which the Court found lacking in this case.
• "A legislative franchise partakes of the nature of a contract." — This statement defines the legal character of a legislative franchise, reinforcing that both the grantee and the government are bound by its terms, including any tax exemptions provided as inducement for the franchise.
• "The presumption is that special statutes are exemptions to the general law because they pertain to special charter granted to meet a particular set of conditions and circumstances" — This articulates the doctrine of special law prevailing over general law, which the Court applied to uphold the franchise's tax exemption provisions over the requirements of the Corporation Law and Public Service Act.

• People vs. Vera, 65 Phil. 56 [1937] — Cited to support the four requisites for judicial inquiry into a constitutional question.
• Province of Misamis Oriental vs. Cagayan Electric Power and Light Company, Inc., G.R. No. L-45355, January 12, 1990, 181 SCRA 38 — Cited for the doctrine that a legislative franchise partakes of the nature of a contract and that tax exemptions are part of the inducement for the acceptance of the franchise. Also cited for the principle that special statutes are exemptions to general laws.
• Butuan Bay Wood Export Corp. vs. CA, G.R. No. L-45473, April 28, 1980, 97 SCRA 297 — Cited to define grave abuse of discretion as a capricious and whimsical exercise of judgment equivalent to lack of jurisdiction.

• Section 8, Article XIV, 1935 Constitution — Prohibits the grant of public utility franchises except to Filipino citizens or corporations at least 60% Filipino-owned. The Court found that Congress excluded international telecommunications operating merely a terminal in the Philippines from this prohibition.
• Section 8, Republic Act No. 808 — Grants tax exemption to the respondent, requiring payment of a 5% franchise tax on gross earnings in lieu of all other taxes. The Court upheld this provision as operative and enforceable.
• Section 15, Republic Act No. 808 — Prohibits the grantee from leasing, transferring, or assigning the franchise without Congressional approval. The Court used this to justify the respondent's inability to restructure its equity prior to Presidential Decree No. 489.
• Section 332(a), National Internal Revenue Code — Allows assessment of taxes within ten years after the discovery of a failure to file a return. The Court applied this to validate the Commissioner's assessment period.
• Section 338-A, National Internal Revenue Code — Governs the non-retroactivity of rulings, regulations, and circulars. The Court held that this provision does not apply to ordinary tax assessments or the revocation of Tax Code provisions.

Narvasa, Cruz, and Griño-Aquino, JJ., concur. Gancayco, J., is on leave.