MARCELO STEEL CORPORATION, PETITIONER, VS. COLLECTOR OF INTERNAL REVENUE, RESPONDENT.

Marcelo Steel Corporation versus Collector of Internal Revenue

The Case

This is a petition for review brought by Marcelo Steel Corporation against the Collector of Internal Revenue, asking the Supreme Court to reverse a judgment of the Court of Tax Appeals that upheld an income tax assessment for the years 1952 and 1953. The petitioner is a corporation engaged in three industrial activities: the manufacture of wire fence, the manufacture of nails, and the manufacture of steel bars, rods and other allied steel products. The last two activities enjoyed tax exemption under Republic Act Number 35, while the manufacture of wire fence did not. The petitioner paid the assessed taxes, then filed amended returns showing that, when all its operations were consolidated, it had actually suffered net losses, and it sought a refund of what it claimed were taxes erroneously paid. The case matters because it fixes the rule on whether the gains of a taxable business may be offset by the losses of a tax-exempt business within one and the same corporation.

Procedural History

The petitioner filed its claim for refund with the Collector of Internal Revenue. After more than ten months passed without any action on the claim, and in order to protect its rights under Section 306 of the National Internal Revenue Code, the petitioner filed a petition for review with the Court of Tax Appeals. The Court of Tax Appeals held that the petitioner cannot deduct from the profits realized from its taxable industries the losses sustained by its tax exempt business activities, and upheld the assessment. The petitioner then brought the matter to the Supreme Court by a petition to review under Section 18 of Republic Act Number 1125, the law governing appeals from the Court of Tax Appeals.

Facts

Marcelo Steel Corporation, organized under Philippine law with offices in Malabon, Rizal, operated three industrial activities: the manufacture of wire fence, the manufacture of nails, and the manufacture of steel bars, rods and other allied steel products. During 1952 and 1953, the manufacture of nails and the manufacture of steel bars and allied products enjoyed tax exemption under Republic Act Number 35. The exemption covered, among others, the income tax with respect to the net income derived from the exempt industry.

On May 21, 1953, the petitioner filed its income tax return for 1952, reflecting a net income of 34,386 pesos and 58 centavos realized solely from the manufacture of wire fence, the non-exempt activity. On March 31, 1954, it filed its return for 1953, showing a net income of 58,329 pesos realized from the same source. On the basis of these returns, which did not reflect the results of the tax-exempt activities, the respondent assessed a total of 12,750 pesos, which the petitioner paid in installments during 1953 and 1954.

On October 1, 1954, the petitioner filed amended returns for both years, showing that it had suffered a net loss of 871,407 pesos and 37 centavos in 1952 and 104,956 pesos and 29 centavos in 1953. These losses were reached by consolidating the gross income and deductions of all its business activities, so that the profits of the wire fence business were swallowed by the far larger losses of the exempt nail and steel bar operations. On the same date, the petitioner filed its request for refund of the 12,750 pesos, claiming it had paid the amount erroneously.

Issues

• Whether or not the petitioner may deduct from the profits realized from its taxable business activities the losses sustained by its tax exempt industries.
• Whether or not the action for refund, with regard to the sum of 3,458 pesos and 50 centavos paid on May 30, 1953, has already prescribed under Section 306 of the Tax Code.

Applicable Provisions

Section 1 of Republic Act Number 35, the law granting the exemption, provides:

Any person, partnership, company, or corporation who or which shall engage in a new and necessary industry shall, for a period of four years from the date of the organization of such industry, be entitled to exemption from the payment of all internal revenue taxes directly payable by such person, partnership, company, or corporation in respect to said industry.

This confines the privilege to the exempt industry itself, which is the textual anchor of the Court's ruling that the exemption cannot spill over into the taxable activity.

Section 7 of Executive Order Number 341, series of 1950, issued by the President pursuant to Section 2 of Republic Act Number 35, provides:

Any industry granted tax exemption under the provisions of Republic Act No. 35 shall report to the Secretary of Finance at the end of every fiscal year a complete list and a correct valuation of all real and personal property of its industrial plant or factory; shall file a separate income tax return; shall keep separately this accounting records relative to the industry declared exempt; shall keep such records and submit such sworn statements as may be prescribed from time to time by the Secretary of Finance.

The requirement of a separate income tax return and separate accounting records shows the intent of the law to treat the exempt industry as separate and distinct from the taxable one for purposes of taxation.

Ruling

On the first issue, the Court held that the petitioner cannot deduct the losses of its tax exempt industries from the profits of its taxable industry. The purpose of Republic Act Number 35 is to encourage the establishment of new and necessary industries, a form of subsidy to entrepreneurs staking capital in an unknown venture, who usually incur loss rather than profit. But the law confined the privilege to new and necessary industries and did not intend to benefit an entrepreneur engaged at the same time in a taxable industry and an exempt one by allowing him to deduct his gains from the first against the losses of the second. A taxable industry is already a going concern deriving profits, deserves no subsidy, and it is but fair that it give the Government a share in its profits in the form of taxes.

The Court added that the single capital answering for all obligations is of no moment, because the intent of the law is to treat taxable industries as separate and distinct from exempt ones. The separate return and separate records required by the Executive Order confirm this. The absence in our National Internal Revenue Code of a prohibition similar to that of the United States Internal Revenue Code cannot be capitalized upon by the petitioner, for Congress, in enacting Republic Act Number 35, intended to segregate income from exempt industries from that of taxable ones. The Court also noted that the petitioner enjoys other exemptions, such as the fixed and privilege tax on business, the percentage tax on sales, the compensating tax and the documentary stamp tax, and these alone suffice to lighten its burdens.

On the second issue of prescription, the Court resolved the case on the first issue and affirmed the judgment under review, with costs against the petitioner.

Doctrine

A tax exemption granted to a new and necessary industry under Republic Act Number 35 is confined to that industry and does not permit the taxpayer to consolidate the gains of its taxable business with the losses of its exempt business. For purposes of taxation, the taxable or non-exempt industry is treated as separate and distinct from the new and necessary industry that is tax exempt. The exemption is a subsidy to lighten financial burdens and reduce losses; it is not designed to assure the entrepreneur a return on his capital, nor to shelter the profits of a going taxable concern. The requirement of a separate income tax return and separate accounting records for the exempt industry reinforces this segregation.

Disposition

The Supreme Court affirmed the judgment of the Court of Tax Appeals upholding the assessment, with costs against the petitioner, Marcelo Steel Corporation.

Remember This

The one line to memorize: the gains of a taxable industry cannot be offset by the losses of a tax exempt industry, because the law treats them as separate and distinct for purposes of taxation. Examiners use this case to test the scope of tax exemptions and the rule that an exemption is construed strictly against the taxpayer and never extends beyond what its language plainly grants.