COMMISSIONER OF INTERNAL REVENUE, PETITIONER, VS. EASTERN TELECOMMUNICATIONS PHILIPPINES, INC., RESPONDENT.

Eastern Telecommunications Philippines versus Commissioner of Internal Revenue

The Case

This is a petition for review on certiorari filed by the Commissioner of Internal Revenue against Eastern Telecommunications Philippines, Incorporated, a domestic telecommunications corporation holding a legislative franchise. The Commissioner asks the Supreme Court to set aside the rulings of the Court of Appeals, which had affirmed the Court of Tax Appeals in granting Eastern a partial refund of unapplied input value-added tax paid on its importation of capital goods. The case matters because it settles two things every tax practitioner must know: first, the procedural limits on raising new issues on appeal, and second, how the rule on apportionment of tax credits applies when a value-added tax registered taxpayer earns both taxable and exempt income. It is a case about the lifeblood of the government meeting the heavy burden of the taxpayer claiming a refund.

Procedural History

Eastern filed with the Commissioner a written application for refund or credit of unapplied input taxes paid on imported equipment for the taxable years 1995 and 1996. Without waiting for the Commissioner's decision, Eastern appealed to the Court of Tax Appeals to toll the running of the two-year prescriptive period. The Court of Tax Appeals, in a decision dated July 17, 2000, partially granted the claim, declaring Eastern entitled to a refund of sixteen million two hundred twenty-nine thousand one hundred pesos, representing unapplied input taxes on imported capital goods for the taxable year 1996. The Commissioner moved for reconsideration, then filed a supplemental motion for reconsideration about a month and a half later. The tax court denied reconsideration. The Commissioner elevated the case to the Court of Appeals through a petition for review under Rule 43 of the Rules of Court. The Court of Appeals affirmed the tax court through its decision dated October 1, 2003 and its resolution dated May 26, 2004 denying reconsideration. Hence, the present petition for review on certiorari before the Supreme Court.

Facts

Eastern is a domestic corporation granted a telecommunications franchise by Congress under Republic Act Number 7617 on June 25, 1992. Under its franchise, Eastern is allowed to install, operate, and maintain a telecommunications system throughout the Philippines. From July 1, 1995 to December 31, 1996, Eastern purchased various imported equipment, machineries, and spare parts necessary in carrying out its business. These importations were subjected to a ten percent value-added tax by the Bureau of Customs, which Eastern duly paid.

On September 19, 1997, Eastern filed with the Commissioner a written application for refund or credit of unapplied input taxes it paid on the imported equipment during the taxable years 1995 and 1996, amounting to twenty-two million thirteen thousand one hundred thirty-four pesos. Eastern principally relied on the provision of its legislative franchise allowing it to pay three percent of its gross receipts in lieu of all taxes. In the alternative, Eastern cited Section 106(B) of the National Internal Revenue Code of 1977, which authorizes a value-added tax registered taxpayer to claim a tax credit certificate or refund of input taxes paid on capital goods imported or purchased locally, to the extent that such input taxes have not been applied against its output taxes.

To toll the two-year prescriptive period, Eastern appealed to the Court of Tax Appeals on September 25, 1997 without waiting for the Commissioner's decision. The Commissioner answered, raising as defenses that the value-added tax on importation is neither a tax on franchise nor on gross receipts, that tax refunds are in the nature of tax exemptions construed strictly against the claimant, and that the burden is on the taxpayer to establish its right to the refund. The tax court ruled for Eastern, not on the basis of the in lieu of all taxes provision of its franchise, but on Section 106(B) of the Tax Code, finding that Eastern was a value-added tax registered entity, that the input tax remained unapplied, and that the application was seasonably filed. The tax court, however, reduced the award, excluding amounts not supported by receipts and excluding input taxes on 1995 equipment already booked as part of cost, since refunding those would amount to twice giving Eastern the tax benefit.

Issues

• Whether or not the rule in Section 104(A) of the Tax Code on the apportionment of tax credits can be applied in appreciating Eastern's claim for tax refund, considering that the matter was raised by the Commissioner only when he sought reconsideration of the tax court ruling.
• Whether or not the Court may relax the rule against raising new issues on appeal in the interest of justice and on grounds of public importance.

Applicable Provisions

Section 106(B) of the National Internal Revenue Code of 1977 provides:

SECTION 106. Refunds or tax credits of input tax. (b) Capital goods. A VAT-registered person may apply for the issuance of a tax credit certificate or refund of input taxes paid on capital goods imported or locally purchased, to the extent that such input taxes have not been applied against output taxes. The application may be made only within two (2) years after the close of the taxable quarter when the importation or purchase was made.

This is the provision on which Eastern anchored its claim and on which the tax court granted the partial refund.

Section 104(A) of the Tax Code provides:

SEC. 104. Tax Credits. (a) Creditable Input tax. A VAT-registered person who is also engaged in transactions not subject to the value-added tax shall be allowed input tax credit as follows: (A) Total input tax which can be directly attributed to transactions subject to value-added tax; and (B) A ratable portion of any input tax which cannot be directly attributed to either activity.

This is the provision the Commissioner invoked to argue that Eastern is entitled only to a ratable portion of the input tax, corresponding to its taxable operations.

Section 15, Rule 44 of the Rules of Court provides:

SEC. 15. Questions that may be raised on appeal. Whether or not the appellant has filed a motion for new trial in the court below, he may include in his assignment of errors any question of law or fact that has been raised in the court below and which is within the issues framed by the parties.

This embodies the rule against raising new issues on appeal, which the Court examines in resolving whether the Commissioner's argument was timely.

Section 4.106-1 of Revenue Regulation Number 7-95 provides:

SEC. 4.106-1. Refunds or tax credits of input tax. (b) Capital Goods. Only a VAT-registered person may apply for issuance of a tax credit certificate or refund of input taxes paid on capital goods imported or locally purchased. The refund shall be allowed to the extent that such input taxes have not been applied against output taxes. The application should be made within two (2) years after the close of the taxable quarter when the importation or purchase was made. Refund of input taxes on capital goods shall be allowed only to the extent that such capital goods are used in VAT taxable business. If it is also used in exempt operations, the input tax refundable shall only be the ratable portion corresponding to the taxable operations.

This regulation confirms that when capital goods are used in both taxable and exempt operations, only the ratable portion is refundable.

Ruling

On the first issue, the Court held that the Commissioner had, in fact, previously questioned the nature of Eastern's transactions in his motion for reconsideration before the tax court, even if he did not specifically cite Section 104(A). The Court reasoned that the applicability of the provision boils down to whether the purchased capital goods were also used in a value-added tax taxable business, and once it is proved that the taxpayer used them in both taxable and non-taxable business, the proportional allocation necessarily applies. That the tax court failed to rule on the question should not be taken against the Commissioner; it was the tax court that erred in failing to avail of the meaningful opportunity to correct the error before appeal.

On the second issue, the Court held that the rule against raising new issues on appeal is not absolute and may be relaxed when compelling reasons so warrant or when justice requires it. The Court found that Eastern's quarterly value-added tax returns for 1996 clearly reported income from exempt sales, and these returns were matters of record that Eastern itself formally offered as evidence. By declaring exempt sales, Eastern effectively admitted it engaged in transactions not subject to value-added tax. The Court quoted its earlier ruling in the Toshiba case:

Since such transactions are not subject to VAT, the sellers cannot pass on any output VAT to the purchasers of goods, properties, or services, and they may not claim tax credit/refund of the input VAT they had paid thereon.

The Court also held that the question involves a matter of public importance, since taxes are the lifeblood of the government and claims for refund partake of the nature of an exemption, strictly construed against the claimant. The taxpayer bears the heavy burden of proving compliance with all statutory and administrative requirements, and this burden cannot be offset by procedural lapses of the government that did not prejudice the taxpayer's due process rights.

Doctrine

A value-added tax registered person who is also engaged in transactions not subject to value-added tax is allowed an input tax credit only for the total input tax directly attributable to taxable transactions, plus a ratable portion of input tax that cannot be directly attributed to either activity, as provided in Section 104(A) of the Tax Code. When capital goods are used in both taxable and exempt operations, the input tax refundable is only the ratable portion corresponding to the taxable operations, consistent with Section 4.106-1 of Revenue Regulation Number 7-95. The rule against raising new issues on appeal under Section 15, Rule 44 of the Rules of Court is not absolute; it may be relaxed in the interest of justice, particularly where the matter is of record and of public importance, and where no prejudice is caused to the adverse party. Claims for tax refund partake of the nature of a tax exemption and are strictly construed against the taxpayer, who bears the heavy burden of proving entitlement.

Disposition

The Court granted the Commissioner's petition, reversed the decision and resolution of the Court of Appeals, and remanded the case to the Court of Tax Appeals to determine the proportionate amount of tax credit to which Eastern is entitled, with costs against Eastern.

Remember This

The single line worth memorizing is that a taxpayer earning both taxable and exempt income may claim a refund only of the ratable portion of input tax corresponding to its taxable operations. Examiners like to use this case to test the rule against raising new issues on appeal and its exceptions, and the principle that tax refunds are construed strictly against the claimant because taxes are the lifeblood of the government.