THE COMMISSIONER OF INTERNAL REVENUE, PETITIONER, VS. PHOENIX ASSURANCE CO., LTD., RESPONDENT; PHOENIX ASSURANCE CO., LTD., PETITIONER VS. COMMISSIONER OF INTERNAL REVENUE, RESP…

Phoenix Assurance versus Commissioner of Internal Revenue

The Case

This is a tax case between the Commissioner of Internal Revenue and Phoenix Assurance Company, Limited, a foreign insurance corporation organized under the laws of Great Britain and licensed to do business in the Philippines, with its head office in London. The Commissioner assessed the company for withholding tax on reinsurance premiums ceded to foreign reinsurers, for deficiency income tax, and for disallowed deductions, while the company sought refunds and resisted the assessments. The case matters because it settles four recurring tax questions in one decision: the withholding tax on ceded reinsurance premiums, the reckoning of the prescriptive period for assessment when an amended return is filed, the deductibility of marine insurance reserves, and the proper base for head office expense allocation.

Procedural History

The company protested the assessments, and when the Commissioner denied the protests, it appealed to the Court of Tax Appeals. Two cases were consolidated and jointly heard there. In a decision dated February 14, 1962, the Court of Tax Appeals allowed in full the deduction for net addition to marine insurance reserve for 1950; fixed the allowable head office expenses at 5 percent of net income in the Philippines; held that the Commissioner's right to assess deficiency income tax for 1952 had prescribed; absolved the company from statutory penalties for non-filing of the withholding tax return; and ordered the company to pay withholding taxes for 1952, 1953 and 1954 and income tax for 1954, while ordering the Commissioner to refund the overpaid income tax for 1953. Both parties appealed to the Supreme Court, which decided the two appeals together.

Facts

Phoenix Assurance, through its London head office, entered into worldwide reinsurance treaties with various foreign insurance companies. Under these treaties it ceded a portion of the premiums it received on original insurances, in exchange for the foreign companies assuming an equivalent portion of the liability. Pursuant to these treaties, it ceded premiums earned from its Philippine underwriting business: 316,526 pesos and 75 centavos for 1952, 246,082 pesos and 4 centavos for 1953, and 203,384 pesos and 69 centavos for 1954. On these ceded premiums the Commissioner assessed withholding tax by letter of May 6, 1958, totaling 183,838 pesos and 42 centavos.

Separately, for 1950 the company claimed a deduction of 37,147 pesos and 4 centavos as net addition to marine insurance reserve, equivalent to 40 percent of gross marine insurance premiums received during the year. The Commissioner disallowed 11,772 pesos and 57 centavos, fixing the reserve at 100 percent of premiums received during the last three months of the year, and assessed deficiency income tax. For 1952, 1953 and 1954, the company claimed head office expenses allocable to Philippine business at 5 percent of gross Philippine income; the Commissioner allowed only 5 percent of net Philippine income and assessed deficiencies.

The company filed its 1952 return on April 1, 1953, showing a loss of 199,583 pesos and 93 centavos. It amended that return on August 30, 1955, reporting a tax liability of 2,502 pesos. On July 24, 1958, after examining the amended return, the Commissioner assessed deficiency income tax of 5,667 pesos. The company also amended its 1953 return and requested a refund of overpaid income tax, filing a petition for review to avoid the prescriptive period.

Issues

• Whether or not reinsurance premiums ceded to foreign reinsurers not doing business in the Philippines, under reinsurance contracts executed abroad, are subject to withholding tax.
• Whether or not the right of the Commissioner of Internal Revenue to assess deficiency income tax for 1952 has prescribed.
• Whether or not the deduction claimed by the company as net addition to reserve for 1950 is excessive.
• Whether or not the deductions claimed for head office expenses allocable to Philippine business for 1952, 1953 and 1954 are excessive.

Applicable Provisions

Section 331 of the Tax Code limits the period for assessment and provides:

Except as provided in the succeeding section, internal-revenue taxes shall be assessed within five years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period. For the purposes of this section a return filed before the last day prescribed by law for the filing thereof shall be considered as filed on such last day: Provided, That this limitation shall not apply to cases already investigated prior to the approval of this Code.

This provision determines whether the assessment for 1952 was timely, counted from the original or the amended return.

Section 32 of the Tax Code, on special deductions of insurance companies, provides:

In the case of insurance companies, whether domestic or foreign, the net additions, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts may be deducted from their gross income.

This governs the deductibility of the marine insurance reserve claimed for 1950.

Section 186 of the Insurance Law requires the setting up of reserves for marine risks:

Provided, That for marine risks the insuring company shall be required to charge as the liability for reinsurance fifty per centum of the premiums written in the policies upon yearly risks, and the full premiums written in the policies upon all other marine risks not terminated.

This fixes the reserve that the deduction under Section 32 must follow.

Section 30 of the Tax Code, on expenses allowable to foreign corporations, provides:

In the case of a non-resident alien individual or a foreign corporation, the expenses deductible are the expenses paid or incurred in carrying on any business or trade conducted within the Philippines exclusively.

This limits the head office expenses deductible to those attributable exclusively to Philippine business.

Ruling

On the first issue, the Court held that the question had already been resolved in the affirmative in British Traders' Insurance Company versus Commissioner of Internal Revenue, decided April 30, 1965. The ceded reinsurance premiums are income from sources within the Philippines and are subject to withholding tax.

On prescription, the Court sustained the Commissioner. The amended return substantially modified the original by excluding reinsurance premiums and related deductions. Moreover, the Commissioner could not have determined a deficiency from the original return because the declared loss of 199,583 pesos and 93 centavos would have more than offset the disallowed head office expense of 15,826 pesos and 35 centavos. The prescriptive period must therefore be counted from the filing of the amended return on August 30, 1955, and less than five years elapsed before the assessment on July 24, 1958. The Court warned that to hold otherwise would pave the way for taxpayers to evade taxes by reporting heavy losses and amending more than five years later.

On the marine reserve, the Court held that neither the company's 40 percent nor the Commissioner's 100 percent of the last three months complied with Section 186. The reserve required is 50 percent of premiums on yearly risks and 100 percent of premiums on other marine risks not terminated. Since the company's claimed deduction was less than what Section 186 requires, it was not excessive and was fully allowed, because a taxpayer may deduct a lesser amount than authorized.

On head office expenses, the Court sustained the Commissioner. The 5 percent must be computed on net income, because the items of income belonging to the Philippine business are not taxable to the Philippine branch and must be excluded, consistent with Section 30.

Finally, on the interest limitation, the Court held that the taxpayer could be liable for statutory penalties only upon its failure to comply with the Tax Court's judgment rendered on February 14, 1962, after Republic Act 2343 took effect. That part of the ruling was left undisturbed.

Doctrine

Reinsurance premiums ceded to foreign reinsurers not doing business in the Philippines, under contracts executed abroad, are income from sources within the Philippines and are subject to withholding tax.

When an amended income tax return substantially modifies the original, the five-year prescriptive period under Section 331 is counted from the filing of the amended return, not the original.

A deduction for marine insurance reserve is not excessive if it is less than the amount required by Section 186 of the Insurance Law, since a taxpayer may deduct a lesser amount than the law authorizes.

Head office expenses deductible by a foreign corporation are limited to those incurred in carrying on business in the Philippines exclusively, so the 5 percent allocation is computed on net Philippine income, not gross.

Disposition

The decision of the Court of Tax Appeals was modified: Phoenix Assurance was ordered to pay withholding taxes for 1952, 1953 and 1954 and income taxes for 1952 and 1954, totaling 192,352 pesos and 42 centavos, while the Commissioner was ordered to refund 20,180 pesos as overpaid income tax for 1953, to be deducted from that total.

Remember This

The single line worth memorizing is that the prescriptive period for assessment runs from the filing of a substantially amended return, not the original. Examiners like to use this case on the withholding tax treatment of ceded reinsurance premiums and on the computation of the marine insurance reserve under Section 186.