Tuesday, January 31, 2012

Anderson vs. Posadas

Facts: William H. Anderson had purchased the business of Erlanger & Galinger. In 1915, he incorporated said partnership under the firm name of Erlanger & Galinger, Inc., with an authorized capital of P600,000, divided into 1,200 shares at the par value of P500 each. All of said shares were subscribed by the incorporator Anderson, who paid in cash, on different dates, the total amount of P70,000. The unpaid balance of P530,000 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.

On January 1, 1918, there was opened in Anderson's name a good will account, upon the debit side of which was entered the sum of P300,000. On the same date, the sum of P300,000 was entered upon the credit side of Anderson's underwriting account, thereby reducing the balance thereof from P530,000 to P230,000.

On said date, January 1, 1918, Anderson sold to Simon 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 January 2d of the same year, 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 P50,000 from the taxable income stated by him in his return for the year 1918, and the sum of P75,000 from his return for the year 1919, or a total amount of P125,000. Said deductions were approved by the Bureau of Internal Revenue.

As the Collector of Internal Revenue attempted to collect tax on the P300,000 at which Anderson assessed the good will of the business' the latter, on December 29, 1923, agreed with the former to eliminate said good will, which in effect was so done by debiting said sum in his capital account and crediting it in the good will account. With said elimination, Anderson's debt of P530,000 was restored. To Feldstein's account was debited the sum of P125,007 which, together with the P100,000 paid by him for the 500 shares which he had bought of Anderson, to the latter's loss, amounts to P225,007. Said sum of P125,007 was the proportional part of the P300,000 which correspondent to Feldstein, for the above-stated 500 shares, at the rate of 7/12 for Anderson and 5/12 for Feldstein.

On January 2, 1924, the sum of P134,169 was debited in Anderson's personal account and that of P95,831 in Feldstein's capital account, in the same proportion of 7/12 for the former and 5/12 for the latter, that is, the amount of P230,000, thereby eliminating the underwriting account.

It appears, therefore, that with the P100,00 paid by Feldstein on account of the 500 shares bought by him Anderson, plus the sum of P125,007 debited to Feldstein's account, which is equivalent to 5/12 of the good will of P300,000, which corresponds to Feldstein for his participation in the share of the corporation, and the above-stated sum of P95,831, the total amount debited in Simon Feldstein's account is P320,838. This amount exceeds the sum of P250,000, which represents the value, at the rate of P500 each, of the 500 shares sold to Feldstein by Anderson. Therefore, as the total of the 500 shares, at the par value of P500 each, has been debited in Feldstein's account, the loss of P125,000 suffered by Anderson at the hearing, by reason of the sale of said 500 shares, has been recovered, and it is but just that the sum of P125,000, deducted from the profits by reason of losses suffered temporarily on the capital, be restored thereto.

(1) Whether or not the lower court erred in holding that the amount of P125,000, found by the appellant as losses recovered, is not subject to income tax; YES

(2) Whether or not the lower court erred in holding that the amount of P155,000, found by the appellant as proceeds from the sale of good will, is not subject to income tax; YES

Held: Good will is the reputation of good name of an establishment. 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. The good will of P155,000 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, which is the proportion of the participation of each in the shares of the corporation Erlanger & Galinger, Inc., that is, P90,412 for Anderson and P64,588 for Feldstein, inasmuch as Anderson's personal debt for the balance of the unpaid shares, was dismissed by said sum of P90,412 and Feldstein's capital account increased by P64,588.

The benefit received by Anderson does not consist merely in the sum of P90,412. He also realized a gain of P70,838 from the sale of 500 shares to Feldstein. Said benefits, added to gather, make a total of P161,250, that is, P6,250 more than the sum of P155,000 on which the defendant and appellant Collector of Internal Revenue is attempting to collect tax from him. 

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