G.R. No. 163835 - Commissioner of Internal Revenue vs. Eastern Telecommunications Philippines, Inc.

Case Summary (G.R. No. 163835)

Factual background

Eastern purchased various imported equipment, machinery, spare parts and related items from July 1, 1995 to December 31, 1996 for use in its telecommunications business. The Bureau of Customs imposed and Eastern paid 10% VAT on those importations. On September 19, 1997 Eastern applied to the CIR for refund or issuance of tax credit certificates for unapplied input taxes allegedly amounting to P22,013,134.00 for the taxable years 1995 and 1996. Eastern principally relied on the franchise provision in RA No. 7617 (the 3% in-lieu provision) and alternatively invoked Section 106(B) of the 1977 Tax Code (refund/tax credit for unapplied input tax on capital goods).

Administrative and tax court proceedings

To preserve the two-year prescriptive period under Section 106(B), Eastern appealed to the Court of Tax Appeals (CTA) on September 25, 1997 without awaiting CIR action; the CIR raised several defenses in its Answer, including that the franchise “in lieu of all taxes” clause should be interpreted as replacing other internal revenue taxes, that VAT on importation is a tax on the privilege of importing and not a franchise tax, and that refunds are in derogation of sovereign power and must be strictly proved by the claimant.

CTA decision and relief awarded

The CTA granted Eastern’s appeal in part. It held that Eastern was entitled to refund/credit under Section 106(B) of the Tax Code because (1) Eastern was VAT-registered; (2) it had paid input VAT on imported capital goods; (3) those input taxes remained unapplied as of the relevant period; and (4) Eastern filed within the two-year prescriptive period. The CTA excluded P525,432.00 for lack of documentary support and excluded P5,360,634.00 relating to 1995 input taxes that had been capitalized (and therefore already forming part of depreciation and cost), concluding that refund of those amounts would constitute a double benefit. The CTA adjudged a refund of P16,229,100.00 for unapplied input taxes on imported capital goods for 1996.

Proceedings in the Court of Appeals and further appeal

The CIR filed motions for reconsideration in the CTA which were denied. Thereafter the CIR appealed to the Court of Appeals (CA) by petition for review; the CA affirmed the CTA decision by decision dated October 1, 2003 and denied reconsideration by resolution dated May 26, 2004. The CIR then filed a petition for review on certiorari with the Supreme Court.

Principal issue on appeal to the Supreme Court

The central issue addressed by the Supreme Court was whether Section 104(A) of the 1977 Tax Code (the rule on apportionment of creditable input tax when a VAT-registered person engages in both VAT-taxable and non-VAT transactions) applied to Eastern’s claimed refund. Closely related was a procedural question: whether the CIR had improperly raised the applicability of Section 104(A) only in a supplemental motion for reconsideration—thereby raising a new issue on appeal that was not properly before the CTA and could not be entertained on appeal.

CIR’s substantive contention regarding apportionment

The CIR argued that, because Eastern’s 1996 quarterly VAT returns showed income from taxable sales, zero-rated sales and exempt sales, Eastern was engaged in both VAT and non-VAT transactions and therefore Section 104(A) required a proportional allocation of the input tax between VAT-taxable and non-VAT activities. Applying the ratio of (taxable sales + zero-rated sales) to total sales to the CTA’s found input tax amount of P16,229,100.00, the CIR computed the refundable portion as P8,814,790.15 and sought that reduction.

Eastern’s procedural and substantive response

Eastern maintained that the CIR failed to timely and properly raise the Section 104(A) apportionment issue before the CTA; the CIR only raised it in a supplemental motion for reconsideration filed beyond the fifteen-day period, so the CTA never had occasion to decide the question. Eastern argued that permitting the CIR to change its theory on appeal would violate due process and fair play, and that the CA correctly found no evidence that Eastern engaged in non-VAT transactions that would trigger Section 104(A).

Legal standard on raising new issues on appeal

The Supreme Court recited the rule embodied in Section 15, Rule 44 of the Rules of Court: an appellant may raise on appeal only questions of law or fact that were raised in the court below and are within the issues framed by the parties. An issue neither averred in pleadings nor raised during trial in the lower court may not be raised for the first time on appeal. The rule exists to protect the adversary and to afford the trial court an opportunity to consider and correct alleged errors.

Court’s analysis of whether the CIR raised the matter below

The Supreme Court examined the CIR’s motion for reconsideration and concluded that, although the CIR did not cite Section 104(A) by number in its original motion, the motion did challenge whether the purchases and claimed input taxes were used in Eastern’s VAT-taxable business and asserted that refund of input taxes on capital goods should be allowed only to the extent those goods were used in VAT-taxable business. The Court therefore found that the CIR had in substance raised the apportionment issue before the CTA and that the CTA had failed to rule on that question—an omission that precluded treating the apportionment as a new issue on appeal.

Application of exceptions to the rule against new issues on appeal

The Court acknowledged exceptions to the general rule against raising new matters on appeal, including the appellate court’s discretion to consider matters of record bearing on an issue submitted even if not specifically pleaded below. The Court considered it appropriate in the interest of justice to accept consideration of Section 104(A) in this case because the factual basis for apportionment — Eastern’s own quarterly VAT returns reporting exempt sales — was in the record and had been formally offered as evidence.

Interpretation

Case Syllabus (G.R. No. 163835)

Facts of the Case

Eastern Telecommunications Philippines, Inc. (Eastern) is a domestic corporation granted a telecommunications franchise by Congress under Republic Act No. 7617 on June 25, 1992, authorizing it to install, operate, and maintain telecommunications systems throughout the Philippines.
Between July 1, 1995 and December 31, 1996, Eastern purchased various imported equipment, machineries, spare parts, fiber optic cables and the like necessary for its business; these importations were subjected to and Eastern duly paid 10% value‑added tax (VAT) to the Bureau of Customs.
On September 19, 1997, Eastern filed with the Commissioner of Internal Revenue (CIR) a written application for refund or credit of unapplied input taxes paid on its imported capital goods for taxable years 1995 and 1996, claiming P22,013,134.00.
Eastern principally relied on Section 10 of RA No. 7617 (the franchise provision allowing payment of 3% of gross receipts "in lieu of all taxes on this franchise or earnings thereof"), and alternatively invoked Section 106(B) of the 1977 National Internal Revenue Code (Tax Code), which permits a VAT‑registered person to apply for a tax credit certificate or refund of input taxes on capital goods to the extent such input taxes have not been applied against output taxes.
To toll the two‑year prescriptive period provided in Section 106(B), Eastern filed an appeal with the Court of Tax Appeals (CTA) on September 25, 1997 without awaiting the CIR’s decision on its administrative refund application.

Procedural History

CIR filed an Answer in the CTA raising special and affirmative defenses, including: (a) Eastern’s administrative claim was pending investigation; (b) the 3% franchise tax should be interpreted strictly as in lieu of all internal revenue taxes; (c) VAT on importation is a tax on the privilege of importing and is not a tax on franchise or gross receipts; (d) the Expanded VAT Law superseded the "in lieu" proviso and the 3% franchise tax did not substitute the 10% VAT on importations; and (e) refunds are in the nature of exemptions and should be strictly construed, with the claimant bearing the burden of proof.
The CTA, in a decision dated July 17, 2000, granted Eastern’s appeal in part, finding entitlement to refund/credit under Section 106(B) of the Tax Code, but only for substantiated unapplied input taxes and only for taxable year 1996; the CTA allowed P16,229,100.00 as refund representing unapplied input taxes on imported capital goods for 1996.
- The CTA disallowed P525,432.00 of Eastern’s claim (the difference between the claimed P22,013,134.00 and the substantiated P21,487,702.00) for lack of supporting receipts, per an independent auditor’s finding.
- The CTA excluded P5,360,634.00 of input taxes on imported equipment for 1995 even though documented, reasoning that those input taxes had been booked as part of the cost of capital equipment and thus already formed part of depreciation — allowing refund of those amounts would duplicate the tax benefit.
CIR filed a motion for reconsideration (August 3, 2000) and a supplemental motion for reconsideration (September 15, 2000); the CTA denied reconsideration in a resolution dated September 20, 2000.
CIR elevated the case to the Court of Appeals (CA) via petition for review under Rule 43 of the Rules of Court. The CA affirmed the CTA in its decision dated October 1, 2003 and denied reconsideration in a resolution dated May 26, 2004.
CIR filed a petition for review on certiorari under Rule 45 before the Supreme Court (this case).

Issues Presented

Whether Eastern is entitled to the full amount of substantiated unapplied input taxes (P16,229,100.00) as determined by the CTA and affirmed by the CA, or whether the apportionment rule under Section 104(A) of the 1977 Tax Code should limit Eastern’s refundable input tax to a ratable portion (as computed by CIR to be P8,814,790.15) because Eastern engaged in both VAT‑taxable and non‑VAT‑taxable (exempt) transactions.
Whether CIR raised the applicability of Section 104(A) for the first time on appeal in violation of the rule against raising new issues on appeal, and if so, whether that procedural infirmity precludes the Court from considering Section 104(A) on certiorari.

Petitioner's (CIR) Arguments

CIR contends the CA erred in affirming the CTA’s full refund award of P16,229,100.00 and that Section 104(A) of the Tax Code on apportionment of tax credits requires that Eastern be limited to a ratable portion of input tax because Eastern engaged in transactions not subject to VAT.
CIR argues that to be entitled to the full refund, Eastern must prove it was engaged exclusively in VAT‑taxable transactions and that the unapplied input taxes were directly attributable to VAT‑taxable transactions.
CIR relies on Eastern’s VAT returns for the four quarters of 1996, which show taxable sales, zero‑rated sales, and exempt sales, with the totals: Taxable Sales 7,924,403.96; Zero‑Rated Sales 557,441,384.27; Exempt Sales 475,541,341.54; Total Sales 1,040,907,129.77 — showing income from exempt sales and thus transactions not subject to VAT.
Applying Section 104(A)’s apportionment formula (Taxable Sales + Zero‑Rated Sales divided by Total Sales, multiplied by the input tax found by CTA), CIR computes the refundable input tax as:
- (7,924,403.96 + 557,445,384.97) / 1,040,907,129.77 × 16,229,100.00 = P8,814,790.15 (CIR’s asserted correct refund).

Respondent's (Eastern) Arguments

Eastern objects that CIR’s arguments based on Section 104(A) were not raised in CIR’s Answer before the CTA and were only introduced belatedly in the CIR’s supplemental motion for reconsideration beyond the 15‑day reglementary period; hence Section 104(A)’s applicability was not timely or properly presented to the CTA.
Eastern claims that permitting CIR to raise Section 104(A) at the appellate stage constitutes a violation of Eastern’s right to due process and is an impermissible change in the theory of the case on appeal.
Eastern asserts that CIR’s new arguments raise factual questions (whether Eastern engaged in non‑VAT tran