G.R. No. L-44007; March 20, 1991
THE COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. COURT OF TAX APPEALS and EASTERN EXTENSION AUSTRALASIA AND CHINA TELEGRAPH COMPANY, LTD., respondents.

FACTS

Private respondent Eastern Extension Australasia and China Telegraph Co., Ltd., a British corporation, operated an international telecommunications cable under a legislative franchise ( Republic Act No. 808 , as amended by R.A. No. 5002 ). Section 8 of its franchise stipulated that the grantee shall pay a 5% tax on its gross Philippine earnings, and such payment “shall be in lieu of all taxes of any kind, nature or description, levied, established or collected by any municipal, provincial or Republic Authority,” except real property tax. The corporation consistently paid this franchise tax from 1952 onward.
In 1971, the Commissioner of Internal Revenue assessed the corporation for deficiency income taxes, inclusive of surcharges and penalties, for the years 1965 to 1970, later expanding the assessment to cover 1952 to 1971. The Commissioner’s position was that the corporation’s franchise was inoperative for violating the 1935 Constitution, which required that public utility franchises be granted only to entities at least 60% Filipino-owned. Consequently, the Commissioner argued the corporation was not entitled to the franchise’s tax exemption and was liable for regular corporate income tax under the National Internal Revenue Code.

ISSUE

The primary issue is whether the Commissioner of Internal Revenue correctly assessed deficiency income taxes against Eastern Extension, notwithstanding the “in lieu of all taxes” provision in its legislative franchise.

RULING

The Supreme Court ruled that the assessment was improperly issued and ordered the case remanded for further proceedings. The Court upheld the constitutionality and operability of Republic Act No. 808 . A legislative franchise, once granted by Congress, is presumed valid and operative until declared otherwise by a competent court. The Commissioner of Internal Revenue does not have the authority to unilaterally declare a franchise unconstitutional and thereby disregard its specific tax provisions. The franchise’s tax exemption clause is binding until the franchise itself is judicially invalidated.
Furthermore, the Court clarified that the assessment could not be considered a “revocation” of a ruling under Section 338-A of the Tax Code, which would have required prospective application. The assessment was based on the Commissioner’s erroneous conclusion of unconstitutionality, not on a revocation of a prior interpretation of the tax laws. However, the Court noted that the franchise tax under Section 8 was in lieu of taxes on income derived from operations within the scope of the franchise. The case was remanded to the Court of Tax Appeals to determine whether the corporation had any taxable income derived from sources outside the franchise’s scope, for which regular income tax might apply. The decision of the CTA cancelling the assessment was set aside for this limited purpose.