Tax avoidance and tax evasion are the two most common ways used by taxpayers to not pay taxes or pay reduced taxes. Tax avoidance is the use of tax-saving devices within the means sanctioned by law and where the taxpayer acts in good faith and at arm's length. Tax evasion, on the other hand, involves schemes outside those lawful means that, when resorted to by taxpayers, usually subjects them to civil or criminal liabilities in addition to penalties and interest on the unpaid tax liabilities. In the case of the Commissioner of Internal Revenue (CIR) v. Hongkong Shanghai Banking Corporation Limited - Philippine Branch (G.R. No. 227121, December 9, 2020), the Supreme Court held that the transactions of the taxpayer were part of a legitimate tax avoidance scheme. In this case, to achieve efficiency, the taxpayer entered into two transactions: the transfer of its sales assets, other information technology assets, and merchant agreements in exchange for shares in a company; and the subsequent sale or assignment of the shares of such company at a premium. The first transaction qualified as a tax-free exchange under Section 40(C)(2) of the National Internal Revenue Code, pursuant to which the transferring taxpayer received shares of stock and gained control over the receiving company.
Two days after the incorporation of the corporation that received the assets and issued shares of stocks to the taxpayer in exchange for the fair market value of the assets received, the taxpayer entered into an agreement for the sale or transfer of the shares received pursuant to the exchange. Less than two months later, the sale and transfer of the shares were completed. Since the second transaction was taxable, the taxpayer paid the documentary stamp taxes and capital gains tax on the shares. The CIR insisted that the second transaction involved an alleged sale of "goodwill", a business asset, and assessed the taxpayer for deficiency income taxes. It was the CIR's position that the gain derived by the taxpayer on the sale should be subject to the regular corporate income tax (then 35 percent) and not on the capital gains tax on the sale of shares. The Supreme Court was not persuaded. It found that the taxpayer simply availed of tax-saving devices within the means sanctioned by law. More importantly, the court recognized that the methodology was adopted by the taxpayer not merely to reduce taxes but also for a legitimate business purpose, i.e., the restructuring of the business to achieve more efficiency and economies of scale. Consequently, what was employed to minimize taxes was a tax avoidance scheme. The Supreme Court thus held that there was no tax evasion.
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