Tuason, Jr. vs. Lingad

Gains from the sale of inherited residential lots are ordinary income, not capital gains, where the taxpayer's conduct shows he was engaged in the real estate business — here, through subdivision and installment sales, improvements, management by an attorney-in-fact, frequency and continuity of sales, and substantial periodic income. A taxpayer who relies in good faith on BIR opinions, including the Commissioner's, is not liable for the 5% surcharge and 1% monthly interest.

Antonio Tuason, Jr. and J. Antonio Araneta stood in a principal–attorney-in-fact relationship over Tuason's Manila real properties. The dispute is governed by the National Internal Revenue Code's definition of "capital assets" and its exclusion of real property used in the taxpayer's trade or business, together with the long-term capital gain provision under section 34.

Antonio Tuason, Jr. inherited from his mother in 1948 several tracts of land, including two contiguous parcels on Pureza and Sta. Mesa streets in Manila with areas of 318 and 67,684 square meters, respectively. While his mother was still alive, she had these two parcels subdivided into twenty-nine lots. Twenty-eight lots were allocated to their then occupants, who had lease contracts with Tuason's predecessor at various times from 1900 to 1903, and those contracts expired on December 31, 1953. The twenty-ninth lot, Lot 29, with an area of 48,000 square meters, more or less, was not leased to any person; it needed filling because of its very low elevation and was planted to kangkong and other crops. After Tuason took possession of the parcels in 1950, he instructed his attorney-in-fact, J. Antonio Araneta, to sell them. The twenty-eight small lots were easily sold because their respective occupants bought them on a ten-year installment basis, but Lot 29 could not be sold immediately because of its low elevation.

Sometime in 1952, Araneta had Lot 29 filled, then subdivided into small lots and paved with macadam roads. The small lots were then sold over the years on a uniform ten-year annual amortization basis. Araneta did not employ any broker and did not put up advertisements for the sale.

In 1953 and 1954 Tuason reported his income from the sale of the small lots — P102,050.79 and P103,468.56, respectively — as long-term capital gains. On May 17, 1957, the Collector of Internal Revenue upheld Tuason's treatment of those gains against a contrary ruling of a revenue examiner. In his 1957 tax return, Tuason again treated his income from the sale of the small lots, P119,072.18, as capital gains and included only one-half thereof as taxable income. In that return he deducted the real estate dealer's tax he paid for 1957; it was explained, however, that the payment of the dealer's tax was on account of rentals received from the twenty-eight lots and other properties. On the basis of the 1957 opinion of the Collector, the revenue examiner approved Tuason's treatment of his income from the sale of the lots. In a memorandum dated July 16, 1962 to the Commissioner of Internal Revenue, the chief of the BIR Assessment Department advanced the same opinion, which the Commissioner concurred in.

On January 9, 1963, the Commissioner reversed himself and considered Tuason's profits from the sales of the lots as ordinary gains. On January 28, 1963, Tuason received a letter from the Bureau of Internal Revenue advising him to pay deficiency income tax for 1957. The letter showed net income per original investigation of P211,095.36; an addition of P59,539.09 representing 56% of the realized profit on the sale of lots deducted in the income tax return and allowed in the original report of examination; net income per final investigation of P270,824.70; less personal exemption of P1,800; amount subject to tax of P269,024.70; tax due of P98,551; less amount already assessed of P72,199; balance of P26,352; plus ½% monthly interest from June 20, 1959 to June 29, 1962 of P4,742.36; and total amount due and collectible of P31,095.36. Tuason's motion for reconsideration was denied.

• Capital Asset Treatment: Petitioner argued that the gains from the sale of the residential lots were gains from the sale of capital assets under section 34(1) of the National Internal Revenue Code, not ordinary gains.
• Leasing Business: Petitioner argued that he was not the one who leased the lots in question.
• Nature of the Lots: Petitioner argued that the lots were residential, not commercial, lots.
• Lease Contracts: Petitioner argued that the leases on the 28 small lots were to last until 1953, before which date he was powerless to eject the lessees.

• Capital Asset Classification: Whether the properties inherited by petitioner and subsequently sold in small lots should be regarded as capital assets, so that the gains are long-term capital gains under section 34(1) of the National Internal Revenue Code, or as real property used in trade or business and therefore ordinary assets.
• Surcharge and Interest: Whether the CTA correctly ordered petitioner to pay a 5% surcharge and 1% monthly interest under section 51(e) of the Revenue Code.

• Capital Asset Classification: No. The properties were real property used in petitioner's trade or business and therefore ordinary assets; the gains were ordinary income, not long-term capital gains under section 34(1).
• Surcharge and Interest: No. The 5% surcharge and 1% monthly interest should be eliminated because petitioner relied in good faith on opinions of the highest BIR officials, including the Commissioner.

• Capital Asset Classification: Section 34(1) defines "capital assets" as all property held by the taxpayer, whether or not connected with his trade or business, but excludes stock in trade or inventory, property held primarily for sale to customers in the ordinary course of trade or business, property used in trade or business subject to depreciation, and real property used in trade or business. The sale of any excluded property produces ordinary gain or loss; only the sale of other property produces capital gain or loss. Because the long-term capital gain provision is a statute of partial exemption, the SC construed tax exemptions strictissimi juris against the taxpayer and liberally in favor of the taxing authority; the field of application of "capital assets" is narrow and its exclusions broad, and the taxpayer bears the burden of bringing himself clearly within the exemption. Still, the SC examined all the circumstances. It held that when petitioner inherited the parcels, what passed to him was not only the duty to respect existing contracts but also the correlative right to receive and enjoy the fruits of the business and property the decedent had established and maintained. The record showed petitioner owned other real properties put out for rent, from which he periodically derived substantial income and for which he paid the real estate dealer's tax, which he deducted from gross income. As far back as 1957 he was receiving rental payments from the 28 small lots even though the leases executed by his mother expired in 1953. Thus, the sales of the several lots forming part of his rental business were sales of non-capital assets. The installment sales of the subdivided lots comprising Lot 29 were no different: the circumstances in combination showed he was engaged in the real estate business — (1) the parcels totaled nearly seven hectares, large enough for a subdivision and located in the heart of Metropolitan Manila; (2) they were subdivided into small lots and sold on installment, a basic earmark of real estate business; (3) comparatively valuable improvements were introduced not simply to liquidate the estate but to make the lots more saleable to the general public; (4) he employed J. Antonio Araneta as attorney-in-fact to develop, manage, administer, and sell the lots, indicating an owner-realty broker relationship; (5) sales were made with frequency and continuity, yielding substantial periodic income; (6) annual sales volume was considerable — P102,050.79 in 1953, P103,468.56 in 1954, and P119,072.18 in 1957; and (7) by his own tax returns, petitioner could not be indubitably adjudged a stranger to the real estate business. The SC therefore found no error in the CTA's holding that the income from the sales was ordinary income.
• Surcharge and Interest: The CTA ordered petitioner to pay the deficiency income tax plus a 5% surcharge and 1% monthly interest under section 51(e) of the Revenue Code. The SC eliminated these additional amounts because petitioner relied in good faith on opinions rendered by no less than the highest officials of the BIR, including the Commissioner himself. It applied the ruling in Connell Bros. Co. (Phil.) vs. Collector of Internal Revenue: Section 183(a) of the NIRC, which imposes a 25% penalty when a percentage tax is not paid on time, contemplates a liability that is undisputed or indisputable; it does not apply where the taxes were paid and the delay concerned a deficiency arising from a controversy over the proper interpretation of circulars, and the controversy was generated in good faith because the BIR itself had formerly taken the taxpayer's view. The SC therefore set aside the surcharge and monthly interest.

• Capital assets under the NIRC — "Capital assets" means property held by the taxpayer, whether or not connected with his trade or business, but excludes stock in trade or inventory, property held primarily for sale to customers in the ordinary course of trade or business, property used in trade or business subject to depreciation, and real property used in trade or business. Gains from selling excluded property are ordinary gains; gains from selling all other property are capital gains. The SC applied this to hold that Tuason's lots were real property used in his real estate and rental business, so the gains were ordinary income.
• Long-term capital gain as statute of partial exemption — Section 34(b)(2) allows only 50% of the net capital gain from the sale of capital assets held for more than twelve months to be taken into account in computing net income. Because this is a partial tax exemption, it is construed strictissimi juris against the taxpayer and liberally in favor of the taxing authority; the field of application of "capital assets" is narrow and the exclusions broad; the taxpayer must clearly bring himself within the exemption, and doubts are resolved against him. The SC applied this burden against Tuason.
• Real estate business indicia — The SC listed seven circumstances that, in combination, showed Tuason was engaged in the real estate business: (1) total area nearly seven hectares, large enough for a subdivision and located in the heart of Metropolitan Manila; (2) subdivision into small lots and sale on installment basis, a basic earmark of real estate business; (3) comparatively valuable improvements introduced not simply to liquidate the estate but to make the lots more saleable to the general public; (4) employment of an attorney-in-fact to develop, manage, administer, and sell the lots, indicating an owner-realty broker relationship; (5) sales with frequency and continuity, producing substantial periodic income; (6) considerable annual sales volume — P102,050.79 in 1953, P103,468.56 in 1954, and P119,072.18 in 1957; and (7) petitioner's own tax returns showed he was not indubitably a stranger to the real estate business. These factors made the gains ordinary income.
• Inheritance of a business — When a taxpayer inherits property, what passes is not merely the duty to respect existing contracts but also the correlative right to receive and enjoy the fruits of the business and property the decedent had established and maintained. The SC used this to treat the leasing business as continuing in Tuason after inheritance.
• Good faith reliance on BIR rulings — A taxpayer who relies in good faith on opinions of the highest BIR officials, including the Commissioner, should not be subjected to the 5% surcharge and 1% monthly interest; the penalty under section 183(a) of the NIRC applies only where the tax liability is undisputed or indisputable, not where the delay arises from a good-faith controversy over interpretation. The SC applied this to eliminate the surcharge and interest.

• "The Tax Code's provision on so-called long-term capital gains constitutes a statute of partial exemption." — The SC uses this characterization to trigger strict construction of the capital-asset exemption against the taxpayer.
• "Under the circumstances, the petitioner's sales of the several lots forming part of his rental business cannot be characterized as other than sales of non-capital assets." — The SC rejects capital-asset treatment for the lots tied to Tuason's rental business.
• "The following circumstances in combination show unequivocally that the petitioner was, at the time material to this case, engaged in the real estate business" — The SC introduces the multi-factor showing that made the Lot 29 installment sales ordinary income.
• "In our opinion this additional requirement should be eliminated because the petitioner relied in good faith upon opinions rendered by no less than the highest officials of the Bureau of Internal Revenue, including the Commissioner himself." — The SC uses this good-faith reliance to set aside the 5% surcharge and 1% monthly interest.

• Connell Bros. Co. (Phil.) vs. Collector of Internal Revenue, 10 SCRA 470 — Applied; its ruling that the 25% penalty under section 183(a) does not apply where the tax liability is disputed and the controversy was generated in good faith supported eliminating the surcharge and interest.
• Esso Standard Eastern, Inc. vs. Acting Commissioner of Customs, 18 SCRA 488 — Cited for the rule that tax exemptions are construed strictissimi juris against the taxpayer and liberally in favor of the taxing authority.
• Philippine Acetylene Co., Inc. vs. Commissioner of Internal Revenue, 20 SCRA 1056 — Cited for the same strictissimi juris rule.
• Philippine Guaranty Co., Inc. vs. Commissioner of Internal Revenue, 15 SCRA 1 — Cited for the same rule, citing La Carlota Sugar Central vs. Jimenez.
• La Carlota Sugar Central vs. Jimenez, L-12436, May 31, 1961 — Cited in Philippine Guaranty for the strictissimi juris rule.
• Klarkowski, TCM 1965-328, aff'd 385 F (2d) 398 (CA-7, 1967) — Cited for the factors used in determining whether property is a capital asset or an ordinary asset.
• Corn Products Refining Co. vs. Commissioner, 350 U.S. 46, 100 L. Ed. 29, 76 S. Ct. 20 — Cited for the principle that exclusions from the term "capital assets" must be interpreted broadly.

• Section 34(1), National Internal Revenue Code (C.A. 466, as amended) — Defines "capital assets" and lists the exclusions, including real property used in the taxpayer's trade or business. The SC applied it to classify Tuason's lots as ordinary assets because they were real property used in his real estate and rental business.
• Section 34(b)(2), National Internal Revenue Code — Provides that if a gain is realized by a taxpayer other than a corporation from the sale or exchange of capital assets held for more than twelve months, only 50% of the net capital gain is taken into account in computing net income. The SC held this did not apply because the lots were not capital assets.
• Section 51(e), Revenue Code — The CTA imposed a 5% surcharge and 1% monthly interest under this provision. The SC set aside that portion of the CTA judgment.
• Section 183(a), National Internal Revenue Code — Imposes a 25% penalty when a percentage tax is not paid on time and contemplates a liability that is undisputed or indisputable. The SC, applying Connell Bros., held it did not justify the surcharge and interest where the deficiency arose from a good-faith controversy over interpretation.
• Section 182(3)(aa) and Section 194(s), National Internal Revenue Code — Section 182(3)(aa) prescribes an annual fixed tax on real estate dealers; section 194(s) defines a "real estate dealer" as including a person engaged in the business of buying, selling, exchanging, leasing, or renting property as principal and holding himself out as a full or part-time dealer, or as an owner of rental property rented or offered to rent for an aggregate amount of four thousand pesos or more a year. The SC noted that Tuason paid the real estate dealer's tax and deducted it from gross income, supporting the finding that the lots were used in his real estate business.
• Article 781, New Civil Code — Provides that inheritance includes not only the property and transmissible rights and obligations existing at the time of death but also those accrued since the opening of succession. The SC cited it to explain that Tuason inherited not only the property but also the correlative right to receive and enjoy the fruits of the business and property his mother had established and maintained.