CASE DIGEST : Manila Gas Corporation v. Collector of Internal Revenue G.R. No. L-42780, January 17, 1936 En Banc

 

FACTS

Manila Gas Corporation, a corporation organized under Philippine law, operated a gas plant in Manila and furnished gas service in Manila and surrounding municipalities under a franchise granted by the Philippine Government. Its stockholders included Islands Gas and Electric Company, a corporation domiciled in New York. Manila Gas also had obligations to Islands Gas and Electric Company and General Finance Company, a corporation domiciled in Zurich, Switzerland.

For the years 1930, 1931, and 1932, Manila Gas paid dividends amounting to P1,348,847.50 to Islands Gas and Electric Company as its stockholder. Manila Gas withheld and paid income taxes amounting to P40,460.03 on those dividends. During the same period, Manila Gas also paid P411,600 in interest on bonds to Islands Gas and Electric Company, upon which it withheld P12,348 in income taxes. It further paid P131,644.90 in interest on other indebtedness to Islands Gas and Electric Company and General Finance Company, withholding P3,949.34 in taxes.

Manila Gas paid the amounts under protest and filed an action against the Collector of Internal Revenue to recover a total of P56,757.37. It argued that the dividends paid to its foreign stockholder should not be subject to income tax because its franchise provided that the stipulated franchise tax would be "in lieu of all taxes", except taxes on specified real and personal property. It also argued that the interest paid to the nonresident corporations was not income from Philippine sources because the payments were made outside the Philippines.

The trial court dismissed Manila Gas's complaint. Manila Gas appealed to the Supreme Court, raising two principal errors: whether the dividends paid to its foreign stockholder were subject to income tax despite the franchise tax exemption, and whether the interest paid to nonresident foreign corporations constituted income from Philippine sources subject to Philippine income tax.

ISSUE

The first issue was whether the dividends paid by Manila Gas Corporation to its foreign stockholder were subject to income tax, notwithstanding the provision in Manila Gas's franchise stating that its payment of 2.5% of gross receipts to the City of Manila and municipalities of Rizal would be in lieu of all taxes, except taxes on specified property. Manila Gas argued that imposing the income tax on the dividends effectively impaired the obligation of its franchise.

The second issue was whether the interest paid by Manila Gas to nonresident foreign corporations constituted income from sources within the Philippines and was therefore subject to Philippine income tax. The Court considered the applicable provisions of Act No. 2833, the Income Tax Law, as amended by Act No. 3761, particularly the provision covering interest on bonds and other interest-bearing obligations of a domestic or resident foreign corporation.

HELD

The Supreme Court affirmed the decision of the trial court. With respect to the dividends, the Court held that the income tax was imposed upon the foreign stockholder receiving the dividends, and not upon Manila Gas itself. The Court relied on the separate juridical personality of a corporation and its stockholders. Because the corporation and its stockholders are distinct persons, a tax imposed upon dividends received by the stockholder does not constitute a tax imposed upon the corporation.

The Court applied its ruling in Philippine Telephone and Telegraph Co. v. Collector of Internal Revenue, holding that dividends of a domestic corporation paid in cash to foreign corporate stockholders are subject to income tax notwithstanding an exemption clause in the corporation's charter. Thus, Manila Gas's franchise provision did not exempt its foreign stockholder from income tax on dividends it received from Manila Gas. The Court therefore overruled Manila Gas's first assignment of error.

As to the interest payments, the Court held that the interest constituted income from sources within the Philippines. Manila Gas conducted its business entirely in the Philippines, and its earnings therefore originated from Philippine sources. The Court explained that the word "source" refers to the origin of the income. The fact that the interest payments may have been delivered outside the Philippines did not change the source of the income because the obligation arose from the business and operations of Manila Gas in the Philippines.

The Court also stated that the question of the constitutionality of Act No. 3761 did not have to be resolved because Manila Gas had not properly raised that constitutional issue in its pleadings, in the trial court's decision, or in its assignments of error. The Court therefore refrained from passing upon it. It concluded that the Collector of Internal Revenue was justified in withholding income taxes on the interest paid to the nonresident corporations because the income was derived from sources within the Philippines as authorized by the Income Tax Law. The judgment was affirmed, with costs against Manila Gas Corporation.