Manila Gas Corporation vs. The Collector of Internal Revenue

Dividends paid by a domestic corporation to its foreign corporate stockholders are subject to Philippine income tax notwithstanding a franchise provision stipulating that a specified franchise tax shall be "in lieu of all taxes," because the corporation has a personality distinct from that of its stockholders, and the taxing power may reach the latter when they receive dividends. Interest on bonds and other indebtedness paid by a domestic corporation operating entirely within the Philippines to non-resident foreign corporations constitutes income from Philippine sources and is subject to Philippine income tax, the word "source" conveying the idea of origin, which in such cases is the Philippines.

Manila Gas Corporation is a domestic corporation organized under Philippine law, operating a gas plant in Manila and furnishing gas service to the metropolis and surrounding municipalities pursuant to a franchise granted by the Philippine Government. Its franchise contains a commutation provision requiring annual payment of two and one-half per centum of gross receipts to the City of Manila and the municipalities of Rizal where gas is sold, "in lieu of all taxes, Insular, provincial and municipal," except taxes on real estate, buildings, plant, machinery, and other personal property belonging to the grantee. Associated with Manila Gas Corporation are two non-resident foreign corporations: the Islands Gas and Electric Company, domiciled in New York, United States, and the General Finance Company, domiciled in Zurich, Switzerland. The Income Tax Law (Act No. 2833), as amended by Act No. 3761, governs the withholding tax obligations at issue, with section 13(e) as amended expressly covering interest on bonds and other obligations paid "within or without the Philippine Islands."

Manila Gas Corporation, a domestic corporation organized under the laws of the Philippine Islands, operates a gas plant in the City of Manila and furnishes gas service to the metropolis and surrounding municipalities under a franchise granted by the Philippine Government. The franchise provides that the grantee shall annually pay two and one-half per centum of gross receipts to the City of Manila and the municipalities of Rizal where gas is sold, "in lieu of all taxes, Insular, provincial and municipal," except taxes on real estate, buildings, plant, machinery, and other personal property belonging to the grantee. Associated with Manila Gas Corporation are two non-resident foreign corporations: the Islands Gas and Electric Company, domiciled in New York, United States, and the General Finance Company, domiciled in Zurich, Switzerland. Neither of these corporations resides in the Philippines.

For the years 1930, 1931, and 1932, Manila Gas Corporation paid dividends in the sum of ₱1,348,847.50 to the Islands Gas and Electric Company in the latter's capacity as stockholder, upon which withholding income taxes totalling ₱40,460.03 were paid to the Collector of Internal Revenue. For the same period, interest on bonds in the sum of ₱411,600 was paid to the Islands Gas and Electric Company, upon which withholding income taxes totalling ₱12,348 were remitted. Interest on other indebtedness in the sum of ₱131,644.90 was likewise paid to the Islands Gas and Electric Company and the General Finance Company, upon which withholding income taxes totalling ₱3,949.34 were paid. The aggregate of these withholding taxes was ₱56,757.37, which Manila Gas Corporation paid under protest and sought to recover.

Some uncertainty existed regarding the place of payment of the interest. The bonds and other tokens of indebtedness were not in the record, but Exhibits E, F, and G, certified correct by the Treasurer of Manila Gas Corporation, purported to show that the place of payment was the United States and Switzerland. Manila Gas Corporation thereafter filed an action against the Collector of Internal Revenue for recovery of the ₱56,757.37. The trial court dismissed the complaint, with costs, applying the doctrine in Philippine Telephone and Telegraph Co. vs. Collector of Internal Revenue, and Manila Gas Corporation appealed.

• Franchise Exemption on Dividends: Petitioner contended that dividends paid to its foreign corporate stockholders were not subject to income tax because imposing such a tax would effectively tax the petitioner corporation itself, in violation of the terms of its franchise, which stipulated that the franchise tax payment shall be "in lieu of all taxes." This argument was predicated on the constitutional prohibition against laws impairing the obligation of contracts.
• Interest Not from Philippine Sources: Petitioner argued that because the Islands Gas and Electric Company and the General Finance Company are domiciled in the United States and Switzerland respectively, and because the interest on bonds and other indebtedness was paid in their respective domiciles, such interest was not income from Philippine sources within the meaning of the Philippine Income Tax Law. Petitioner cited sections 10(a) and 13(e) of Act No. 2833 and relied on the decisions in Manila Railroad Co. vs. Collector of Internal Revenue and Philippine Railway Co. vs. Posadas.
• Constitutionality of the Amendatory Statute: Petitioner alternatively argued that, assuming the amendment introduced by Act No. 3761 to section 13 of Act No. 2833 was intended to cover interest from Philippine sources, the amendatory statute was invalid and unconstitutional as exceeding the Legislature's power to enact.

• Amendment by Act No. 3761: Respondent countered that the decisions cited by the appellant (Manila Railroad Co. and Philippine Railway Co.) interpreted the Income Tax Law before it was amended by Act No. 3761, which expressly extended coverage to interest on bonds and other obligations paid "within or without the Philippine Islands."

• Taxability of Dividends Under Franchise Exemption: Whether dividends paid by a domestic corporation to its foreign corporate stockholders are subject to Philippine income tax notwithstanding a franchise provision stipulating that the franchise tax shall be "in lieu of all taxes."
• Situs of Interest Income: Whether interest on bonds and other indebtedness paid by a domestic corporation to non-resident foreign corporations outside the Philippines constitutes income from Philippine sources subject to Philippine income tax.
• Constitutionality of Act No. 3761: Whether the amendatory statute (Act No. 3761) is invalid and unconstitutional as exceeding legislative power.

• Taxability of Dividends Under Franchise Exemption: Yes. Dividends paid by a domestic corporation to foreign corporate stockholders are subject to income tax, the corporation having a personality distinct from its stockholders, enabling the taxing power to reach the latter. The exemption clause in the corporation's charter does not extend to the stockholders' dividend income.
• Situs of Interest Income: Yes. Interest on bonds and other indebtedness paid by a domestic corporation operating entirely within the Philippines to non-resident foreign corporations constitutes income from Philippine sources, the word "source" conveying the idea of origin, which in this case is the Philippines.
• Constitutionality of Act No. 3761: Not passed upon. The constitutional question was not raised in the pleadings, the trial court's decision, or the assignment of errors, and no jurisdictional issue being involved, the Court declined to rule on it.

• Taxability of Dividends Under Franchise Exemption: The Court applied the doctrine in Philippine Telephone and Telegraph Co. vs. Collector of Internal Revenue (58 Phil. 639), which held that a corporation has a personality distinct from that of its stockholders, enabling the taxing power to reach the latter when they receive dividends. Although the tax-exemption provision in Manila Gas Corporation's franchise differs in phraseology from that in the Telephone and Telegraph Company's franchise, the ratio decidendi is substantially the same. The exemption clause in the charter of the corporation shields the corporation itself from additional taxes but does not extend to the stockholders' separate income derived from dividends. It is settled that dividends of a domestic corporation paid and delivered in cash to foreign corporations as stockholders are subject to income tax, the exemption clause in the charter of the corporation notwithstanding.

• Situs of Interest Income: The Court applied the doctrine that no state may tax anything not within its jurisdiction without violating due process, the taxing power not extending beyond territorial limits. However, if income is taxed, the recipient must have a domicile within the state, or the property or business out of which the income issues must be situated within the state, so that the income may be said to have a situs therein. The Court found that Manila Gas Corporation operates its business entirely within the Philippines, and its earnings therefore come from local sources. The place of physical delivery of the interest to the foreign corporations, paid out of the revenue of the domestic corporation, is of no particular moment. Even if the place of payment were conceded to be outside the country, it cannot alter the fact that the income was derived from the Philippines. The word "source" conveys only one idea — that of origin — and the origin of the income was the Philippines. The Court distinguished the cases of Manila Railroad Co. vs. Collector of Internal Revenue and Philippine Railway Co. vs. Posadas on their particular facts, noting that the facts at bar are clearly different. The Court also observed that some uncertainty existed concerning the place of payment, as the bonds and other tokens of indebtedness were not in the record.

• Constitutionality of Act No. 3761: The Court declined to pass on the constitutional question because it was not raised in the pleadings, the decision of the trial court, or the assignment of errors. No jurisdictional issue was involved, and the Court did not consider it its duty to rule on the question. The Court cited Cadwaller-Gibson Lumber Co. vs. Del Rosario (26 Phil. 192) and other authorities in support of this procedural posture.

• Corporate Personality Distinct from Stockholders for Taxation — A corporation has a personality distinct from that of its stockholders, enabling the taxing power to reach the latter when they receive dividends from the corporation. A tax-exemption or commutation clause in a corporation's franchise that shields the corporation from taxes does not extend to the stockholders' dividend income. The Court applied this doctrine to hold that dividends paid by Manila Gas Corporation to its foreign corporate stockholders were taxable notwithstanding the franchise's "in lieu of all taxes" provision, following Philippine Telephone and Telegraph Co. vs. Collector of Internal Revenue.

• Situs of Income Taxation — Source as Origin — The taxing power of a state does not extend beyond its territorial limits, but within such limits it may tax persons, property, income, or business. If income is taxed, the recipient must have a domicile within the state, or the property or business out of which the income issues must be situated within the state so that the income may be said to have a situs therein. The word "source" conveys only one idea — that of origin. The Court applied this doctrine to hold that interest paid by a domestic corporation operating entirely within the Philippines to non-resident foreign corporations constitutes income from Philippine sources, regardless of where payment was physically delivered, because the origin of the income was the Philippines.

• Judicial Restraint on Constitutional Questions — A court will not pass on the constitutionality of a statute when the question was not raised in the pleadings, the decision of the trial court, or the assignment of errors, and no jurisdictional issue is involved. The Court declined to rule on the constitutionality of Act No. 3761 because the issue was not properly raised.

• "It must be considered as settled in this jurisdiction that dividends of a domestic corporation, which are paid and delivered in cash to foreign corporations as stockholders, are subject to the payment in the income tax, the exemption clause in the charter of the corporation notwithstanding." — This passage states the ratio decidendi on the first issue, establishing that franchise tax exemptions do not extend to stockholders' dividend income.

• "The word 'source' conveys only one idea, that of origin, and the origin of the income was the Philippines." — This passage articulates the controlling interpretive principle for determining the situs of income for taxation purposes, defining "source" as origin rather than place of payment.

• "The Manila Gas Corporation operates its business entirely within the Philippines. Its earnings, therefore come from local sources. The place of material delivery of the interest to the foreign corporations paid out of the revenue of the domestic corporation is of no particular moment." — This passage applies the "source as origin" doctrine to the facts, holding that a domestic corporation's Philippine operations fix the Philippine situs of interest income regardless of where payment is delivered.

• Philippine Telephone and Telegraph Co. vs. Collector of Internal Revenue, 58 Phil. 639 (1933) — Controlling precedent followed on the first issue. Held that a corporation's personality is distinct from its stockholders, so the taxing power may reach stockholders receiving dividends, notwithstanding the corporation's franchise tax-exemption clause. The Court found the ratio decidendi substantially the same despite differences in the phraseology of the exemption provisions.
• Manila Railroad Co. vs. Collector of Internal Revenue, G.R. No. 31196 (Dec. 2, 1929, unreported) — Distinguished. Had held that interest on bonds purchased outside the Philippines by non-residents is not income from Philippine sources. The Court distinguished it on its particular facts, noting that the facts at bar are clearly different.
• Philippine Railway Co. vs. Posadas, 58 Phil. 968 (1933) — Distinguished. Similarly held that interest paid to non-resident individuals or corporations is not income from Philippine sources. Distinguished on its facts.
• Farmers Loan Co. vs. Minnesota, 280 U.S. 204 (1930) — Cited as authority on the doctrine that no state may tax anything not within its jurisdiction, and that debts owing by corporations are obligations of the debtors and only possess value in the hands of the creditors.
• Cadwaller-Gibson Lumber Co. vs. Del Rosario, 26 Phil. 192 (1913) — Cited in support of the Court's refusal to pass on the constitutionality of Act No. 3761, the question not having been raised in the pleadings or assignment of errors.
• Farrington vs. Tennessee, 95 U.S. 679 (1878) — Cited by Justice Goddard in dissent on the first issue, as authority that a franchise commutation provision extending "in lieu of all taxes" protection also shields stockholders from additional taxation, as impairing the obligation of contract.

• Section 10(a), Act No. 2833 (Income Tax Law) — Cited by the appellant in support of the argument that interest paid to non-resident corporations is not income from Philippine sources. The Court's disposition did not turn on this provision directly.
• Section 13(e), Act No. 2833, as amended by Act No. 3761 — Expressly provides for the imposition of a tax upon income derived from interest upon bonds and mortgages, or deeds of trust, notes, or other interest-bearing obligations of a domestic or resident foreign corporation, paid "within or without the Philippine Islands." The Solicitor-General relied on the amendment to distinguish the earlier cases cited by the appellant. The Court sustained the taxation of interest under this provision, finding the income to be from Philippine sources.
• Franchise of Manila Gas Corporation (commutation clause) — Provides that the grantee shall annually pay two and one-half per centum of gross receipts "in lieu of all taxes, Insular, provincial and municipal," except taxes on real estate, buildings, plant, machinery, and other personal property belonging to the grantee. The Court held this clause inapplicable to shield stockholders' dividend income from taxation.
• Constitutional provision against impairment of contracts — Invoked by the appellant to argue that taxing dividends would impair the franchise contract. The Court rejected this argument, holding that the franchise exemption protects the corporation, not its stockholders.
• Due process clause (territorial jurisdiction to tax) — Applied through the doctrine that no state may tax anything not within its jurisdiction, the taxing power not extending beyond territorial limits. The Court found that the income had a situs in the Philippines because the business out of which it issued was situated in the Philippines.

Hull, Vickers, Imperial, Butte, and Recto, JJ., concurred in the majority decision. No separate concurring opinions were filed by these justices beyond their concurrence.

• Villa-Real, J. (concurring and dissenting): Concurred with the majority on the disposition of the second assigned error (interest income from Philippine sources) but dissented on the first. He maintained that the exemption clause in Manila Gas Corporation's franchise is broader in scope than that in the Philippine Telephone and Telegraph Company's franchise, rendering the doctrine in that case inapplicable.

• Abad Santos, J. (concurring in part and dissenting in part): Dissented on the first assigned error, arguing that the franchise is a contract whose obligation cannot be impaired. The dividends paid to stockholders were part of the corporation's earnings and, as such, not subject to tax under the terms of the franchise. Concurred with the majority on the second assigned error, citing section 13(e) of Act No. 2833 as amended by Act No. 3761 and quoting Justice Bradley in United States vs. Erie R. Co. for the proposition that a tax on the debt (the rem) is permissible even as against non-resident bondholders, because the money is within the jurisdiction before transmission.

• Avanceña, C.J. (dissenting): Dissented on the second assigned error, arguing that the question had been clearly decided in Manila Railroad Co. vs. Collector of Internal Revenue, which held that interest on bonds purchased outside the Philippines by non-residents cannot be considered derived from sources within the Islands. The amendment introduced by Act No. 3761 as to the place of payment does not affect the analysis if the interest is not in fact derived from sources within the Islands.

• Goddard, J. (dissenting): Dissented on both assigned errors. On the first, he argued that the franchise commutation clause is a contract between the Government and the grantees, and that once the franchise tax is paid, the Government has no legal right to impose another tax on the corporation's earnings. He relied extensively on Farrington vs. Tennessee (95 U.S. 679) and Bank of Commerce vs. Tennessee (16 U.S. 134), which held that a charter's "in lieu of all other taxes" provision extends to stockholders and bars additional taxation as impairing the obligation of contract. On the second error, he concurred with the dissent of Chief Justice Avanceña. He would have reversed the trial court and ordered the Collector to pay the plaintiff ₱56,757.37.