University of the Philippines College of Law

D2021

Case No. G.R. No. 44100

Case Name Anderson v Posadas
Ponente villa-real

RELEVANT FACTS

Anderson purchased the business of Erlanger & Galinger. He incorporated said partnership under the firm name of Erlanger
& Galinger, Inc., with an authorized capital of P600K, divided into 1,200 shares at the par value of P500 each. All of said
shares were subscribed by the incorporator Anderson who paid the total amount of P70K. The unpaid balance of P530K was
entered in an intermediary account, called underwriting account, which was opened in the corporation in Anderson's name, in
place of his personal account.

Subsequent to this, there was opened in Anderson's name a goodwill account, upon the debit side of which was entered the
sum of P300K. On the same date, the sum of P300K was entered upon the credit side of Anderson's underwriting account,
thereby reducing the balance thereof from P530K to P230K.

On the same day, Anderson sold to Feldstein 200 shares at the rate of 2 to 1, receiving in payment thereof the sum of P
50,000 with a loss of P50,000.

On the next day, Anderson sold 300 more shares to Feldstein at the rate of 3 to 1, and received in payment thereof the sum of
P50,000, having lost P100,000 in the transaction.

In view of said losses, Anderson deducted the sum of P50K from the taxable income stated by him in his return for the year
1918, and the sum of P75K from his return for the year 1919, or a total amount of P125K. Said deductions were approved by
the Bureau of Internal Revenue.

The following is an appeal from the decision of the CFI of Manila which ruled:

xx

4. Approving the deduction of the sum of P42,542.63 representing 100 per cent surcharge on income tax, disapproved in
1921; .

5. Holding that the amount of P155,000, representing the alleged proceeds of the supposed sale of the "Goodwill Account", is
not subject to income tax, and .

6. Holding that the amount of P125,000, representing an allegedly recovered loss, is not subject to income tax.

RATIO DECIDENDI
Issue Ratio

1. WON the sum of P42K paid NO. The fines paid as penalty by a taxpayer cannot be deducted from the amount
by Anderson as penalty for fraud subject to the payment of income tax
committed in his income tax
returns may be deducted from Act No. 2833 Sec. 5 enumerates the items that may be deducted in computing the net
the income tax return made by income of a citizen or resident of the Philippines, but the amount paid as penalty for
him? fraud is not mentioned among them.

Additionally, the Department of Finance promulgated Regulation No. 20. Sec. 33 of

said regulation, in interpreting the word "taxes," provides, among other things, as
follows: "The word 'taxes' means taxes proper and no deductions should be allowed for
amounts representing interest or penalties incident to delinquency."

Related to this, Black provides:

FINES AND PENALTIES. — Fines paid because of a violation of law are not
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D2021

deductible even if the violation is in connection with a trade or business.

Items of this type are deemed not to arise from the ordinary and necessary
conduct of business

It appears, therefore, that fines imposed for violation of law cannot be considered taxes
paid to the Government, which should be deducted from income subject to the
payment of income tax. The tax under consideration is levied on income, while the
fine is paid as penalty for violation of the Internal Revenue Law. The fine, therefore,
cannot be considered a tax, inasmuch as it is not levied on income.
2. WON the amount of YES. The amount deducted from the income by reason of temporary partial loss from
P125,000, found by the appellant the capital should, upon the recovery of said loss, be restored to the profits and pay the
as losses recovered, is subject to corresponding tax
the payment of income tax.
The CIR and Anderson entered into an agreement to eliminate the good will. This was
done by debiting said sum in his capital account and crediting it in the good will
account. With said elimination, Anderson's debt of P530K was restored. Feldstein was
then debited P125K (plus the P100K he has paid for the shares).

In the process of eliminating the underwriting in Anderson's personal account,

Feldstein was debited P95K and Anderson P135K.

Therefore, the P100K paid by Feldstein and the P125K that was debited against him
for his participation in the share of the corporation, and the P95K abovestated, the total
amounts to P320K. This amount exceeds the P250K value of the purchased shares. As
a result, the previous losses of Anderson has been recovered. As a consequence, it is
but just that the sum of P125K, deducted from the profits by reason of losses suffered
temporarily on the capital, be restored thereto.

It is not attempted to consider the sum of P125K as profit obtained from the sale of the
500 shares to Feldstein by Anderson, but as the restoration of a temporarily loss in the
same amount, which was deducted from the income corresponding to the years 1918
and 1919.
3. WON the amount of P155K, YES. The good will created by an incorporator in the course of the business of a
found by the appellant as corporation and appraisal to pay the unpaid [price of shares subscribed to by said
proceeds form the sale of good incorporator, is a profit and is subject to the payment of income tax.
will, is subject to income tax, is
assigned as third alleged error. The phrase "good will" is defined in 28 Corpus Juris, 729, section 1, as follows:

Good will may be defined to be the advantage or benefit which is acquired by

an establishment, beyond the mere value of the capital stock, funds, or
property employed therein in consequence of the general public patronage
and encouragement which it receives from constant or habitual customers on
account of its local position or common celebrity or reputation for skill,
affluence, punctuality, or from other accidental circumstances or necessities,
or even from accident partialities or prejudices

If the good will, that is, the good reputation of the business is acquired in the course of
its management and operation, it does form part of the capital with which it was
established. It is an intangible moral profit, susceptible of valuation in money, acquired
by the business by reason of the confidence reposed in it by the public, due to the
efficiency and honesty shown by the manager and personnel thereof in conducting the
same on account of the courtesy accorded its customers, which moral profit, once it is
valuated and used, becomes a part of the assets.

In this case, the good will of P155K created by Anderson has been beneficial not only
to him but also to Feldstein in the proportion of 7/12 for Anderson and 5/12 for
Feldstein. The benefit received by Anderson does not consist merely in the sum of
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D2021

P90K. He also realized a gain of P70K from the sale of 500 shares to Feldstein. Said
benefits, added to gather, make a total of P161K, that is, P6K more than the sum of
P155K on which the defendant and appellant Collector of Internal Revenue is
attempting to collect tax from him.

RULING
Wherefore, the appealed judgment is reversed in so far as it (1) approves the deduction of the amount of P42,542.63, which represents 100 per cent
surcharges on income tax; (2) holds that the amount of P125,000, deducted from the income as loss which was recovered later, is not subject to income tax,
and (3) holds that the amount of P155,00, representing the proceeds of the sale of good will, is not subject to income tax, and the defendant is absolved from
the complaint, with the costs to the plaintiff. So ordered.