Vicente Madrigal, et al. vs. James J.

Rafferty, et al.

Republic of the Philippines

EN BANC

G.R. No. L-12287 August 7, 1918

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs-appellants,

Gregorio Araneta for appellants.

MALCOLM, J.:

This appeal calls for consideration of the Income Tax Law, a law of American origin, with
reference to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE.

Vicente Madrigal and Susana Paterno were legally married prior to January 1, 1914. The
marriage was contracted under the provisions of law concerning conjugal partnerships
(sociedad de gananciales). On February 25, 1915, Vicente Madrigal filed sworn declaration on
the prescribed form with the Collector of Internal Revenue, showing, as his total net
income for the year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the
claim that the said P296,302.73 did not represent his income for the year 1914, but was in
fact the income of the conjugal partnership existing between himself and his wife Susana
Paterno, and that in computing and assessing the additional income tax provided by the Act
of Congress of October 3, 1913, the income declared by Vicente Madrigal should be divided
into two equal parts, one-half to be considered the income of Vicente Madrigal and the
other half of Susana Paterno. The general question had in the meantime been submitted to
the Attorney-General of the Philippine Islands who in an opinion dated March 17, 1915,
held with the petitioner Madrigal. The revenue officers being still unsatisfied, the
correspondence together with this opinion was forwarded to Washington for a decision by
the United States Treasury Department. The United States Commissioner of Internal
Revenue reversed the opinion of the Attorney-General, and thus decided against the claim
of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely
by the Collector of Internal Revenue, action was begun by Vicente Madrigal and his wife
Susana Paterno in the Court of First Instance of the city of Manila against Collector of
Internal Revenue and the Deputy Collector of Internal Revenue for the recovery of the sum
of P3,786.08, alleged to have been wrongfully and illegally collected by the defendants
from the plaintiff, Vicente Madrigal, under the provisions of the Act of Congress known as
the Income Tax Law. The burden of the complaint was that if the income tax for the year
1914 had been correctly and lawfully computed there would have been due payable by each
of the plaintiffs the sum of P2,921.09, which taken together amounts of a total of P5,842.18
instead of P9,668.21, erroneously and unlawfully collected from the plaintiff Vicente
Madrigal, with the result that plaintiff Madrigal has paid as income tax for the year 1914,
P3,786.08, in excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the
pleadings, and the stipulation, sets forth the basis of defendants' stand in the following
way: The income of Vicente Madrigal and his wife Susana Paterno of the year 1914 was
made up of three items: (1) P362,407.67, the profits made by Vicente Madrigal in his coal
and shipping business; (2) P4,086.50, the profits made by Susana Paterno in her
embroidery business; (3) P16,687.80, the profits made by Vicente Madrigal in a pawnshop
company. The sum of these three items is P383,181.97, the gross income of Vicente
Madrigal and Susana Paterno for the year 1914. General deductions were claimed and
allowed in the sum of P86,879.24. The resulting net income was P296,302.73. For the
purpose of assessing the normal tax of one per cent on the net income there were allowed
as specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at
source, and (2) P8,000, the specific exemption granted to Vicente Madrigal and Susana
Paterno, husband and wife. The remainder, P271,614.93 was the sum upon which the
normal tax of one per cent was assessed. The normal tax thus arrived at was P2,716.15.
The dispute between the plaintiffs and the defendants concerned the additional tax
provided for in the Income Tax Law. The trial court in an exhausted decision found in favor
of defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants having to do solely with the additional income
tax, is that is should be divided into two equal parts, because of the conjugal partnership
existing between them. The learned argument of counsel is mostly based upon the
provisions of the Civil Code establishing the sociedad de gananciales. The counter
contentions of appellees are that the taxes imposed by the Income Tax Law are as the name
implies taxes upon income tax and not upon capital and property; that the fact that
Madrigal was a married man, and his marriage contracted under the provisions governing
the conjugal partnership, has no bearing on income considered as income, and that the
distinction must be drawn between the ordinary form of commercial partnership and the
conjugal partnership of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been
given the course of history. The final stage has been the selection of income as the norm of
taxation. (See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the
United States, extended to the Philippine Islands, is the result of an effect on the part of the
legislators to put into statutory form this canon of taxation and of social reform. The aim
has been to mitigate the evils arising from inequalities of wealth by a progressive scheme
of taxation, which places the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the minimum of
subsistence. With these exceptions, the income tax is supposed to reach the earnings of the
entire non-governmental property of the country. Such is the background of the Income
Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference
between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by
the payment of money from it or any other benefit rendered by a fund of capital in relation
to such fund through a period of time is called an income. Capital is wealth, while income is
the service of wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court
of Georgia expresses the thought in the following figurative language: "The fact is that
property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree,
income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a
tax on property. "Income," as here used, can be defined as "profits or gains." (London
County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S.,
605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition
[1915], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs.
Mahon [1890], 136 U.S., 549; and Towne vs. Eisner, decided by the United States Supreme
Court, January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband
and wife not living apart, contains the following:

The husband, as the head and legal representative of the household and general custodian
of its income, should make and render the return of the aggregate income of himself and
wife, and for the purpose of levying the income tax it is assumed that he can ascertain the
total amount of said income. If a wife has a separate estate managed by herself as her own
separate property, and receives an income of more than $3,000, she may make return of
her own income, and if the husband has other net income, making the aggregate of both
incomes more than $4,000, the wife's return should be attached to the return of her
husband, or his income should be included in her return, in order that a deduction of
$4,000 may be made from the aggregate of both incomes. The tax in such case, however,
will be imposed only upon so much of the aggregate income of both shall exceed $4,000. If
either husband or wife separately has an income equal to or in excess of $3,000, a return of
annual net income is required under the law, and such return must include the income of
both, and in such case the return must be made even though the combined income of both
be less than $4,000. If the aggregate net income of both exceeds $4,000, an annual return
of their combined incomes must be made in the manner stated, although neither one
separately has an income of $3,000 per annum. They are jointly and separately liable for
such return and for the payment of the tax. The single or married status of the person
claiming the specific exemption shall be determined as one of the time of claiming such
exemption which return is made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine
Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the
conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish
authorities were cited, this court in speaking of the conjugal partnership, decided that
"prior to the liquidation the interest of the wife and in case of her death, of her heirs, is an
interest inchoate, a mere expectancy, which constitutes neither a legal nor an equitable
estate, and does not ripen into title until there appears that there are assets in the
community as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose [1916],
15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)
Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her
husband Vicente Madrigal during the life of the conjugal partnership. She has an interest in
the ultimate property rights and in the ultimate ownership of property acquired as income
after such income has become capital. Susana Paterno has no absolute right to one-half the
income of the conjugal partnership. Not being seized of a separate estate, Susana Paterno
cannot make a separate return in order to receive the benefit of the exemption which would
arise by reason of the additional tax. As she has no estate and income, actually and legally
vested in her and entirely distinct from her husband's property, the income cannot
properly be considered the separate income of the wife for the purposes of the additional
tax. Moreover, the Income Tax Law does not look on the spouses as individual partners in
an ordinary partnership. The husband and wife are only entitled to the exemption of
P8,000 specifically granted by the law. The higher schedules of the additional tax directed
at the incomes of the wealthy may not be partially defeated by reliance on provisions in our
Civil Code dealing with the conjugal partnership and having no application to the Income
Tax Law. The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney-General of the
Philippine Islands and the United States Treasury Department. The decision of the latter
overruling the opinion of the Attorney-General is as follows:

TREASURY DEPARTMENT, Washington.

Income Tax.

FRANK MCINTYRE,
Chief, Bureau of Insular Affairs, War Department,
Washington, D. C.

SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of
correspondence "from the Philippine authorities relative to the method of submission
of income tax returns by marred person."

You advise that "The Governor-General, in forwarding the papers to the Bureau,
advises that the Insular Auditor has been authorized to suspend action on the
warrants in question until an authoritative decision on the points raised can be
secured from the Treasury Department."

From the correspondence it appears that Gregorio Araneta, married and living with
his wife, had an income of an amount sufficient to require the imposition of the net
income was properly computed and then both income and deductions and the specific
exemption were divided in half and two returns made, one return for each half in the
names respectively of the husband and wife, so that under the returns as filed there
would be an escape from the additional tax; that Araneta claims the returns are correct
on the ground under the Philippine law his wife is entitled to half of his earnings; that
Araneta has dominion over the income and under the Philippine law, the right to
determine its use and disposition; that in this case the wife has no "separate estate"
within the contemplation of the Act of October 3, 1913, levying an income tax.

It appears further from the correspondence that upon the foregoing explanation, tax
was assessed against the entire net income against Gregorio Araneta; that the tax was
paid and an application for refund made, and that the application for refund was
rejected, whereupon the matter was submitted to the Attorney-General of the Islands
who holds that the returns were correctly rendered, and that the refund should be
allowed; and thereupon the question at issue is submitted through the Governor-
General of the Islands and Bureau of Insular Affairs for the advisory opinion of this
office.

By paragraph M of the statute, its provisions are extended to the Philippine Islands, to
be administered as in the United States but by the appropriate internal-revenue
officers of the Philippine Government. You are therefore advised that upon the facts as
stated, this office holds that for the Federal Income Tax (Act of October 3, 1913), the
entire net income in this case was taxable to Gregorio Araneta, both for the normal
and additional tax, and that the application for refund was properly rejected.

The separate estate of a married woman within the contemplation of the Income Tax
Law is that which belongs to her solely and separate and apart from her husband, and
over which her husband has no right in equity. It may consist of lands or chattels.

The statute and the regulations promulgated in accordance therewith provide that
each person of lawful age (not excused from so doing) having a net income of $3,000
or over for the taxable year shall make a return showing the facts; that from the net
income so shown there shall be deducted $3,000 where the person making the return
is a single person, or married and not living with consort, and $1,000 additional where
the person making the return is married and living with consort; but that where the
husband and wife both make returns (they living together), the amount of deduction
from the aggregate of their several incomes shall not exceed $4,000.

The only occasion for a wife making a return is where she has income from a sole and
separate estate in excess of $3,000, but together they have an income in excess of
$4,000, in which the latter event either the husband or wife may make the return but
 not both. In all instances the income of husband and wife whether from separate
estates or not, is taken as a whole for the purpose of the normal tax. Where the wife
has income from a separate estate makes return made by her husband, while the
incomes are added together for the purpose of the normal tax they are taken
separately for the purpose of the additional tax. In this case, however, the wife has no
separate income within the contemplation of the Income Tax Law.

Respectfully,

DAVID A. GATES.
Acting Commissioner.

In connection with the decision above quoted, it is well to recall a few basic ideas. The
Income Tax Law was drafted by the Congress of the United States and has been by the
Congress extended to the Philippine Islands. Being thus a law of American origin and being
peculiarly intricate in its provisions, the authoritative decision of the official who is
charged with enforcing it has peculiar force for the Philippines. It has come to be a well-
settled rule that great weight should be given to the construction placed upon a revenue
law, whose meaning is doubtful, by the department charged with its execution. (U.S. vs.
Cerecedo Hermanos y Cia. [1907], 209 U.S., 338; In re Allen [1903], 2 Phil., 630; Government
of the Philippine Islands vs. Municipality of Binalonan, and Roman Catholic Bishop of
Nueva Segovia [1915], 32 Phil., 634.) We conclude that the judgment should be as it is
hereby affirmed with costs against appellants. So ordered.

Torres, Johnson, Carson, Street and Fisher, JJ., concur.

Short Title
Vicente Madrigal, et al. vs. James J. Rafferty, et al.
G.R. Number
G.R. No. L-12287
Date of Promulgation
August 07, 1918