Taxability of Indemnity Payment Made through a Compromise Agreement

February 17, 1969 BIR RULING NO. 004-69 Attorney Porfirio C. David Roque and David Law Offices Suites 310-316 J. M. Tuazon Bldg. 303 Escolta, Manila S i r : This refers to your letter dated March 2, 1968 requesting a ruling as to whether or not indemnity payment made through a compromise agreement under the facts stated in your query is taxable. prcd As you represented, the facts of the case are as follows: "On March 29, 1950 the Court of First Instance of Rizal, in Civil Case No. 131, authorized government expropriation of the Gonzales Estate, at Baesa, Caloocan City, on the condition "that the Republic of the Philippines will resell the property to its occupants at its cost price". "The late Anselmo Dimasaca, our clients' predecessor-in-interest, was one of the bonafide tenants of the Estate, who acquired a vested right to buy the same from the Government by virtue of said decision." "The Estate was, accordingly, subdivided in accordance with the occupancy of the tenants, but in the process, certain portions thereof were reserved and segregated as road-right-of-way for the North Diversion Road, without benefit of expropriation proceedings. As a result our clients' lot was reduced, the difference having been withheld by the Government for the purpose mentioned above, without indemnifying our clients therefor. LLpr "Consequently, our clients were forced to sue the Government in the aforesaid Civil Case No. C-558. On July 17, 1967, the Court of First Instance of Rizal rendered judgment, holding that Government holds title to the Gonzales Estate in trust for the tenants-occupants thereof, and as such trustee, has no right to appropriate for itself any portion thereof, without due compensation and ordering the Government to indemnify our said clients at the rate of P30.00 per square meter. "Both parties are now exploring the possibility of an amicable settlement, which how hinges solely in the matter of price. "It is our belief that the aforesaid indemnity is not subject to tax, as it is obviously being paid to compensate for a loss of an existing property right. It is the "just compensation" required by the Constitution in eminent domain proceedings, which represents the full equivalent value of the property taken by the Government. To our mind, taxing said indemnity would constitute an indirect diminution of the "just compensation" guaranteed by our Constitution and would therefore, be violative thereof." In reply, I have the honor to inform you that pursuant to Section 29 of the Tax Code, gross income includes gains, profits, and income derived from salaries, wages or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, business, commerce, sales, or dealings in property, whether real or personal growing out of ownership or use of or interest in such property ; also from interest, rents, dividends, securities, or the transactions of any business carried on for gains, profits and income derived from any source whatsoever. prll Accordingly, this Office believes and so holds that the amount received or to be received by your client through a compromise agreement with the Government for the latter's unlawful encroachment of your client's right to a portion of the Gonzales Estate, insofar as said amount exceeds the purchase price of the portion of land adverted to in your query, constitutes gross income under Section 29 of the Tax Code. Hence, said amount is taxable. For further elucidation, it may also be stated that if the indemnity payment referred to in your query were the just compensation in expropriation proceedings as contemplated by law, said payment would nevertheless be taxable because the taking of property through condemnation proceedings and the payment of just compensation therefor is a sale or exchange within the meaning of Section 117(a) of the Revenue Act of the United States of 1936 (counterpart of Section 29 of the Tax Code of the Philippines); and profits from that transaction constitute capital gain. (1942, Com. Internal Revenue v. Kisselback (CCA3) 1277 (24) 359 (David Brown v. Comm. 1942, 42 BTA 139). cdt Very truly yours, (SGD.) MISAEL P. VERA Commissioner of Internal Revenue