G.R. No. 147188 - Commissioner of Internal Revenue vs. Estate of Toda, Jr.

Case Summary (G.R. No. 147188)

Petitioner

The Commissioner of Internal Revenue sought reversal of the Court of Appeals’ affirmation of the Court of Tax Appeals’ cancellation of a deficiency income tax assessment against CIC (and against the estate of CIC’s controlling shareholder), arguing the two-step sale was a sham designed to convert corporate taxable gain into a lower-rated individual capital gain.

Respondent and Related Entities

The Estate of Benigno P. Toda, Jr. (representing the late principal shareholder and controller of CIC) defended against the deficiency assessment. CIC is the corporate transferor of the property; Altonaga was the alleged intermediary purchaser who paid capital gains tax; RMI was the party that ended up acquiring the property and had debited amounts in its trial balance reflecting investment in the Cibeles Building.

Key Dates

2 March 1989: CIC authorized Toda to sell the Cibeles Building for not less than P90,000,000.
30 August 1989: Deeds of Absolute Sale executed — CIC → Altonaga (P100,000,000); Altonaga → RMI (P200,000,000).
4 May and 31 July 1989: RMI trial balance entries showing debits of P40,000,000 and another P40,000,000 as “other inv. Cibeles Bldg.”
16 April 1990: CIC filed its 1989 corporate income tax return, declaring gain from sale of real property P75,728,021 and paying net tax P26,341,207.
12 July 1990: Toda sold his CIC shares to Le Hun T. Choa (Deed of Sale of Shares of Stock containing an undertaking by Toda to hold buyer and CIC free from tax liabilities for FYs 1987–1989).
16 January 1994: Death of Benigno P. Toda, Jr.
29 March 1994: BIR sent an assessment and demand letter to CIC for deficiency income tax (P79,099,999.22).
9 January 1995: Notice of Assessment issued to the Estate for deficiency income tax (P79,099,999.22).
15 February 1996: Estate filed petition with CTA; subsequent CTA and Court of Appeals decisions favored the Estate; the Commissioner appealed further.

Applicable Law and Constitutional Framework

The decision applies the 1987 Philippine Constitution as the governing constitutional framework and the National Internal Revenue Code of 1986 (NIRC) and its pertinent sections cited by the Court: Section 24 (rates on corporations; then 35% for income above threshold), Section 34(h) (individual capital gains taxation at 5% then), and Section 269 (exceptions to period of limitation for false or fraudulent returns — ten-year rule). The decision also references the Tax Reform Act amendments where relevant to nomenclature of sections.

Statement of Relevant Facts

CIC, essentially controlled by Toda (owner of 99.991% of shares), executed a transaction whereby on the same day two notarized deeds showed a sale to Altonaga (P100M) and, immediately, a resale by Altonaga to RMI (P200M). Altonaga paid P10M in capital gains tax for his supposed gain. CIC’s 1989 return reported a comparatively small gain and paid tax accordingly. Evidence showed RMI had earlier debited amounts reflecting investment in the property and that substantial funds (P40M) flowed from RMI prior to the formal sale to Altonaga. Toda later sold his shares and contractually agreed to hold buyer and CIC free of tax liabilities for FYs 1987–1989; he subsequently died, and the Estate received the assessment.

Assessment and Computation of Deficiency

The Commissioner’s assessment computed CIC’s net income by adding an additional P100,000,000 gain (the alleged concealed gain) to the reported 1989 net income of P75,987,725 to arrive at a total taxable income of P175,987,725. At the 35% corporate rate, tax due was P61,595,703.75. After crediting payments (P26,595,704 per return and P10,000,000 via capital gains tax paid by Altonaga), a balance of P24,999,999.75 remained. Surcharges and interest (a 50% surcharge, a 25% surcharge, and interest at 20% for specified period) were added, producing a total assessed amount of P79,099,999.22.

Procedural History

The Estate protested; the Commissioner dismissed the protest as based on a fraudulent scheme designed to convert corporate income into individual capital gains. The Estate filed a CTA petition; the CTA found no proof of fraud, treated the transactions as tax avoidance, held the three-year prescriptive period applicable, and cancelled the assessment. The Court of Appeals affirmed the CTA. The Commissioner appealed to the Supreme Court, which was called to resolve whether the transactions amounted to tax evasion, whether the assessment period had prescribed, and whether the Estate could be liable.

Issues Presented

Whether the two-step sales constituted tax evasion (fraud) rather than legitimate tax avoidance.
Whether the period for assessment for the 1989 deficiency income tax had prescribed.
Whether the Estate of Toda could be held personally liable for CIC’s deficiency income tax.

Analysis — Tax Evasion versus Tax Avoidance

The Court distinguished tax avoidance (lawful use of means sanctioned by law to reduce tax) from tax evasion (use of unlawful means, accompanied by bad faith, to avoid tax). It identified three integral elements of tax evasion: (1) an end to pay less than legally due, (2) a culpable state of mind (willful/deliberate/bad faith), and (3) an unlawful course of action or omission. The Court found these elements present: the timing and substance of transactions (RMI’s early payments and trial balance entries identifying investment in the Cibeles Building), the lack of economic substance in Altonaga’s acquisition, and the Estate’s own admission that the sale to Altonaga was part of tax planning to change the structure of proceeds to lower tax liability supported the inference that the two-step sale was a sham. The sale to Altonaga was found to lack the normal incidents of ownership and was a mere conduit operation to transform what was substantively a CIC→RMI sale into an apparent individual capital gain for Altonaga. The Court held that such formalistic steps designed solely to alter tax liabilities should be disregarded for tax purposes, and the transactions must be viewed in substance as a single direct sale by CIC to RMI.

Analysis — Tax Treatment and Legal Consequence

Viewing the transaction as a single sale by CIC to RMI, the gain is taxable as corporate income governed by the corporate tax rate (then 35% under Section 24 of the NIRC) rather than as an individual capital gain at 5% under Section 34(h). Therefore, the Commissioner’s imposition of corporate tax on the concealed P100,000,000

Case Syllabus (G.R. No. 147188)

Case Citation and Panel

G.R. No. 147188; Decision date: September 14, 2004; reported at 481 Phil. 626.
Decision authored by Chief Justice Davide, Jr.; Justices Quisumbing, Ynares‑Santiago, Carpio, and Azcuna concurred.
Case reviewed prior decisions of the Court of Appeals (CA-G.R. SP No. 57799, Decision of January 31, 2001) and the Court of Tax Appeals (CTA Case No. 5328, Decision of January 3, 2000).

Parties and Posture

Petitioner: Commissioner of Internal Revenue (Commissioner Liwayway Vinzons‑Chato).
Respondent: The Estate of Benigno P. Toda, Jr., represented by Special Co‑Administrators Lorna Kapunan and Mario Luza Bautista.
Nature of the petition: Petition for review filed by the Commissioner challenging the CA’s affirmance of the CTA’s cancellation of a deficiency income tax assessment against the Estate for alleged deficiency income tax of Cibeles Insurance Corporation (CIC) for taxable year 1989.

Factual Background — Core Transactions

CIC authorized Benigno P. Toda, Jr. (President and beneficial owner of virtually all CIC shares — 99.991%) to sell the 16‑storey Cibeles Building and the two parcels on which it stood (Ayala Avenue, Makati) for not less than P90 million (authorization dated March 2, 1989). [CA Rollo, 73]
August 30, 1989: Deeds of Absolute Sale show a purported sale by Toda (on behalf of CIC) to Rafael A. Altonaga for P100 million, notarized the same day and by the same notary as a subsequent deed showing Altonaga selling the same property to Royal Match, Inc. (RMI) for P200 million. [CA Rollo, 74–78; 88–92]
For the sale from Altonaga to RMI, Altonaga paid capital gains tax of P10 million. [Exh. “E,” CTA Records, 306]
As early as May 4, 1989, CIC received P40 million from RMI (reflected by RMI as “other inv. Cibeles Bldg.” in its trial balance); another P40 million was reflected in RMI’s trial balance as of July 31, 1989. [Exh. 3, CTA Records, 476; Exh. 6, CTA Records, 470]
CIC filed its corporate annual income tax return for 1989 on April 16, 1990, declaring gain from sale of real property of P75,728,021, crediting withholding taxes of P254,497 and paying P26,341,207 on declared net taxable income of P75,987,725. [Exh. “L,” CTA Records, 340; Exh. “M,” “M‑1,” “N,” “N‑1,” CTA Records, 316–317]
July 12, 1990: Toda sold his entire shares in CIC to Le Hun T. Choa for P12.5 million (Deed of Sale of Shares of Stock). [Exh. “P,” CTA Records, 357–365]
January 16, 1994: Toda died.

Notice of Assessment and Computation of Deficiency

March 29, 1994: BIR sent an assessment notice and demand letter to CIC for alleged deficiency income tax for year 1989 amounting to P79,099,999.22. [BIR Records, 448–449]
January 9, 1995: Notice of Assessment dated and later received by the Estate on January 27, 1995, assessed the Estate (as successor) for P79,099,999.22 as computed below: [BIR Records, 474–475]
- 1989 Net Income per return: P75,987,725.00
- Add: Additional gain on sale of real property (taxable as ordinary corporate income but substituted with individual capital gains): P100,000,000.00
- Total Net Taxable Income per investigation: P175,987,725.00
- Tax due at 35%: P61,595,703.75
- Less payments already made:
  - Per return: P26,595,704.00
  - Capital gains tax paid by Altonaga: P10,000,000.00
  - Total credits: P36,595,704.00
- Balance of tax due: P24,999,999.75
- Add 50% surcharge: P12,499,999.88
- Add 25% surcharge: P6,249,999.94
- Subtotal: P43,749,999.57
- Add interest 20% from 4/16/90–4/30/94 (.808): P35,349,999.65
- Total amount due & collectible: P79,099,999.22

Procedural History (Administrative and Judicial Steps)

Estate filed letter of protest following assessment. [Exh. “H,” CTA Records, 314–315]
Commissioner dismissed the protest in a letter dated October 19, 1995, finding a deliberate fraudulent scheme by CIC to cover up the additional gain of P100 million and thereby evade the higher corporate income tax rate. [Exh. “G,” CTA Records, 311–312]
February 15, 1996: Estate filed petition for review with the CTA alleging lack of proof of fraud, improper redirection of assessment against the Estate, and prescription of the Commissioner’s right to assess.
Commissioner filed Answer and Amended Answer asserting: (a) the two transactions were a single sale by CIC to RMI with Altonaga as a mere conduit; (b) CIC’s income tax return was false/fraudulent with intent to evade tax; (c) discovery of fraud occurred on March 8, 1991, making the January 9, 1995 assessment timely under the ten‑year rule for false returns. [CTA Records, 104–111; 121–128]
January 3, 2000: CTA Decision held Commissioner failed to prove fraud, characterized the transactions at most as tax avoidance, found assessment prescribed under three‑year rule (Section 203 of NIRC), and cancelled the January 9, 1995 assessment. [CTA Records 535–540]
CTA denied Commissioner’s motion for reconsideration. [CTA Records, 534, 539; Id., 550; CA Rollo, 32]
Court of Appeals affirmed the CTA on January 31, 2001, giving deference to CTA’s tax expertise. [Rollo, 30]
Commissioner filed petition for review to the Supreme Court raising three assignments of error: (1) CA erred in holding no fraud with intent to evade tax; (2) CA erred in not disregarding CIC’s separate corporate personality; and (3) CA erred in holding petitioner’s right to assess had prescribed. (CA Rollo, 7–20)

Parties’ Principal Contentions

Commissioner:
- The two sales constituted a single sale by CIC to RMI; Altonaga was not a true buyer or seller but a conduit/dummy for Toda/CIC.
- The P100 million differential was taxed at only 5% as Altonaga’s capital gains instead of 35% corporate income tax of CIC, demonstrating a fraudulent scheme to evade tax.
- The Deed of Absolute Sale sequence (Altonaga→RMI notarized before CIC→Altonaga) and the fact that CIC received P40 million from RMI before the purported sale support the scheme.
- The BIR discovered the falsity/fraud on March 8, 1991; the assessment of January 9, 1995 is within ten years from discovery and therefore timely.
Estate of Toda:
- Argued the assessment should have been directed against the old CIC and not the new CIC (after sale of shares), and that the Estate was bound by contractual undertakings.
- Asserted the Commissioner failed to present Altonaga’s income tax return to prove his financial incapacity; contended conduct amounted to tax planning or tax avoidance, not evasion.
- Admitted that the sale to Altonaga was part of a tax‑planning scheme and defended it as legitimate