THE COMMISSIONER OF INTERNAL REVENUE, PETITIONER, VS. COURT OF TAX APPEALS, EASTERN EXTENSION AUSTRALASIA AND ASIA TELEGRAPH COMPANY, LTD., RESPONDENTS.

Eastern Extension Australasia and China Telegraph Company versus Commissioner of Internal Revenue

The Case

This is a petition for review brought by the Commissioner of Internal Revenue against the Court of Tax Appeals and the Eastern Extension Australasia and China Telegraph Company, a foreign corporation organized under the laws of Great Britain and engaged in international telecommunications. The Commissioner assails the tax court's decision cancelling a deficiency income tax assessment of 21,523,288 pesos and 37 centavos, and its resolution denying reconsideration. The case matters because it teaches the hierarchy between a special legislative franchise and general statutes, the contract nature of a franchise and its tax exemption clause, and the discipline of avoiding a constitutional question when the case may be decided on other grounds.

Procedural History

The controversy began when the Commissioner assessed the company for deficiency income tax for the years 1965 to 1970, and later re-assessed it from 1952 to 1971 in the aggregate amount of 21,523,288 pesos and 37 centavos. The company filed a petition for review with the Court of Tax Appeals, contesting the legality of the assessment and praying for a restraining order. The Court of Tax Appeals rendered its decision on February 18, 1976, reversing the Commissioner and cancelling the assessment as without legal force and effect. It held the franchise unconstitutional, but cancelled the assessment on the ground that it was made beyond the prescribed period under the Tax Code, and that the assessment, being tantamount to a revocation of the franchise tax, could not be given retroactive effect. The Commissioner's motion for reconsideration was denied on June 18, 1976. The Commissioner then filed this petition for review with the Supreme Court.

Facts

By a Royal Decree of the Spanish Government dated March 30, 1898, the company was given a concession to construct, operate, and maintain a submarine telegraph cable from Hongkong to Manila. When that concession expired on June 21, 1952, Republic Act No. 808 was approved, granting the corporation a legislative franchise to land, construct, maintain, and operate at Manila a submarine telegraph cable connecting Manila with Hongkong. Section 8 of that law granted it exemption from all taxes, municipal, provincial, or national, except a franchise tax of five percent on gross earnings and the tax on its real property. In 1967, Republic Act No. 5002 amended the franchise by enlarging its scope to telecommunications by cable or other means between any point in the Philippines and points outside it. The company duly reported its gross Philippine earnings and paid the five percent franchise tax beginning 1952.

On November 25, 1971, the Commissioner assessed the company for deficiency income tax for 1965 to 1970. The assessment rested on the belief that the franchise was inoperative for failure to comply with the constitutional requirement that a public utility franchise be granted only to citizens of the Philippines or to corporations organized under Philippine laws with sixty percent of the capital owned by Filipinos. The company disputed the assessment in letters dated 17 and 18 January 1972, questioning the Commissioner's authority and invoking the franchise and its exclusive tax feature, and raising prescription. On February 28, 1973, the Commissioner rejected the company's position and re-assessed it from 1952 to 1971 in the aggregate amount of 21,523,288 pesos and 37 centavos.

Meanwhile, on July 24, 1974, President Ferdinand Marcos promulgated Presidential Decree No. 489 authorizing the company to transfer and assign its franchise to the Eastern Telecommunications Philippines, Inc., a corporation organized under Philippine laws with at least sixty percent of its capital owned by Filipino citizens, and the company thereafter transferred its franchise. The Court of Tax Appeals then rendered the assailed decision, and the case reached the Supreme Court on petition for review.

Issues

• Whether or not the constitutionality of the legislative franchise should have been passed upon by the Court of Tax Appeals when it was not an issue raised in the pleadings.
• Whether or not the provision in the franchise requiring payment of only five percent of gross receipts in lieu of any and all taxes is unenforceable and without effect, considering that the franchise is inoperative for failure of the corporation to comply with the requirements of the Constitution, the Corporation Law, and the Public Service Act.
• Whether or not the Court of Tax Appeals acted in excess of its jurisdiction in declaring the assessment fantastic and fabulous, considering that there had been no trial on the merits.
• Whether or not the assessment was issued within the period prescribed by law.
• Whether or not the Commissioner's assessment is in the nature of a ruling within the purview of Section 338-A of the National Internal Revenue Code.

Applicable Provisions

Section 8 of Article Fourteen of the 1935 Constitution provides:

No franchise, certificate or any other forms of authorization for the operation of a public utility shall be granted except to citizen of the Philippines or to corporations or other entities organized under the laws of the Philippines sixty per centum of the capital of which is owned by citizens of the Philippines, nor shall such franchise, certificate or authorization be exclusive in character or for a longer period than fifty years.

This is the constitutional requirement the Commissioner invoked to argue that the franchise, and therefore its tax exemption, was inoperative.

Section 8 of Republic Act No. 808 provides:

In consideration of the franchise and rights hereby granted, the Grantee shall pay to the Republic of the Philippines during the life of this franchise a tax of five percent of the gross earnings derived by the Grantee from its operation under this franchise and which originate in the Philippines. Such tax shall be due and payable annually, within ten (10) days after the audit and approval of the accounts as prescribed in section seven of this Act, and shall be in lieu of all taxes of any kind, nature and description, levied, established or collected by any municipal, provincial or Republic authority except that the Grantee shall pay the tax of its real property in conformity with existing law.

This is the tax exemption clause in lieu of all taxes that the Commissioner sought to disregard.

Section 15 of Republic Act No. 808 provides:

The Grantee shall not lease, transfer, grant the usufruct of, sell or assign this franchise nor the rights and privileges acquired thereunder to any person, firm, company, corporation or other commercial or legal entity, nor merge with any other company or corporation organized for the same purpose, without the approval of the Philippine Congress first had.

This provision explains why the company could not restructure its equity to meet the sixty percent Filipino ownership requirement before the decree of 1974.

Ruling

On the first issue, the Court sustained the tax court's finding that the constitutional issue was squarely raised by the parties, but held that it was not necessary for the disposition of the case. The Court laid down the requisites of a judicial inquiry into a constitutional question, including the necessity that the question be passed upon in order to decide the case, and found that the last requisite was absent. The Court held that the tax court should have avoided the issue and maintained the presumption of constitutionality, since the case could be resolved on other available grounds.

On the second issue, the Court held that the tax exemption clause was valid and enforceable. A legislative franchise partakes of the nature of a contract, and the franchise is the law between the parties, who are bound by its terms. The Commissioner, being a government agency, is also bound. The Court held that the Commissioner cannot declare the franchise ineffective and unenforceable merely by stating that the company failed to comply with general statutes not mentioned in Republic Act No. 808. A special law applicable only to the corporation prevails over general statutes such as the Public Service Act and the Corporation Law, because special statutes are exemptions to the general law. The Court also held that the company could not be faulted for not restructuring its equity, since Section 15 of its franchise prohibited transfer without prior congressional approval, which came only with Presidential Decree No. 489 in 1974.

On the third issue, the Court found no grave abuse of discretion in the tax court's characterization of the assessment, since the case could be resolved on the other grounds obtaining.

On the fourth and fifth issues, the Court upheld the tax court's ruling that the assessment was made beyond the prescribed period under the Tax Code, and that the assessment, being tantamount to a revocation of the franchise tax, could not be given retroactive effect under the Tax Code.

Doctrine

A legislative franchise partakes of the nature of a contract between the sovereign power and the grantee, made upon valuable consideration for individual advantage as well as public benefit, and it is the law between the parties. The tax exemption clause in a franchise is part of the inducement for its acceptance, and the government, including the Commissioner of Internal Revenue, is bound by its terms. A special legislative franchise prevails over general statutes of general application, such as the Public Service Act and the Corporation Law, because special statutes are exemptions to the general law. Courts must avoid deciding a constitutional question unless it is necessary to decide the case, and must maintain the presumption of constitutionality of a statute. A grantee cannot be penalized for failing to comply with a constitutional ownership requirement when its own franchise prohibits the transfer that compliance would require without prior congressional approval.

Disposition

The petition was denied and the decision of the Court of Tax Appeals cancelling the assessment was affirmed, with the Commissioner failing to obtain its annulment.

Remember This

The single line worth memorizing is that a legislative franchise is a contract and the law between the parties, and a special franchise prevails over general statutes. Examiners use this case to test the hierarchy of special and general laws, the contract nature of franchises and their tax exemptions, and the rule that a constitutional question will not be passed upon unless it is necessary to decide the case.