G.R. No. L-53961, June 30, 1987
NATIONAL DEVELOPMENT COMPANY, petitioner, vs. COMMISSIONER OF INTERNAL REVENUE, respondent.

FACTS

The National Development Company (NDC), a domestic corporation, entered into contracts in Tokyo with Japanese shipbuilders for the construction of twelve vessels. The purchase price was financed through bonds issued by the Central Bank, with initial payments made via cash and letters of credit. For the balance, NDC executed fourteen promissory notes, which were guaranteed by the Republic of the Philippines. The vessels were constructed, delivered in Tokyo, and NDC subsequently remitted interest payments on the unpaid balance totaling US$4,066,580.70 to the Japanese shipbuilders in Tokyo.
The Commissioner of Internal Revenue (CIR) assessed NDC for deficiency income tax, asserting that the interest income received by the non-resident Japanese corporations was subject to Philippine income tax and that NDC, as the payer, failed to withhold the tax. After failed negotiations, the BIR served a warrant of distraint and levy. The Court of Tax Appeals (CTA) sustained the CIR’s position, holding NDC liable as a withholding agent. NDC elevated the case to the Supreme Court via petition for certiorari.

ISSUE

Whether the interest income paid by NDC to the non-resident Japanese shipbuilders is derived from sources within the Philippines, making it subject to Philippine income tax, and consequently, whether NDC is liable for failure to withhold said tax.

RULING

The Supreme Court affirmed the CTA decision, ruling that the interest income is derived from sources within the Philippines and NDC is liable as a withholding agent. The Court applied Section 37(a)(1) of the National Internal Revenue Code, which treats interest derived from sources within the Philippines, including interest on obligations of residents, as gross income from Philippine sources. The legal logic hinges on the “source” of the interest, which is determined by the residence of the obligor, not the place of activity, contract signing, or payment.
The Court emphasized that the law focuses on the obligor’s residence. Since NDC is a domestic corporation and a resident of the Philippines, the interest paid on its promissory notes is unequivocally interest from Philippine sources, taxable to the Japanese recipients. The Court rejected NDC’s argument that all activities occurred in Tokyo, as the statutory language does not require a Philippine situs of activity. Furthermore, the Court found no merit in the claim that the notes were government securities exempt under Section 29(b)(4), as the obligor was NDC, a corporate entity, not the Philippine government itself.
As the payer-resident, NDC was mandated under Section 53(c) to withhold the tax. The Court cited precedent establishing that a withholding agent must strictly comply with its obligations and cannot be released from liability without a prior ruling from the CIR if in doubt. NDC’s failure to withhold rendered it personally liable for the tax. The decision underscores a strict interpretation of tax liability provisions and the definitive rule that the residence of the obligor dictates the source of interest income.