c. Prohibition on Compensation and Set-off

Equitable Recoupment

When a taxpayer is entitled to a claim for refund but he was not able to file a written claim within the prescribed time, the taxpayer is allowed to credit the amount for refund against his existing liability. This is not allowed in the Philippines and is applied in common law countries.

Prohibition on Compensation and Set-Off

Taxes are not subject to set-off or legal compensation because the government and the taxpayer are not mutual creditor and debtor of each other. (Republic v. Mambulao Lumber Company, G.R. No. L-17725, 28 February 1962¹; Caltex Philippines, Inc. v. COA, G.R. No. 92585, 8 May 1992²)

Section 204 of the NIRC³ governs the Commissioner's authority to compromise, abate, and refund or credit taxes; it does not prohibit compensation. This means that taxpayers cannot unilaterally offset their tax liabilities with claims against the government.

Facts:

Philex Mining Corporation (Philex) was assessed deficiency excise taxes by the Bureau of Internal Revenue (BIR) for the years 1992 to 1994. Philex did not initially pay these assessments, leading to the issuance of warrants of distraint and levy against its properties. In 1997, Philex and the BIR reached a compromise agreement, whereby Philex paid a portion of the assessed deficiency taxes while contesting the remaining assessments.

Simultaneously, Philex had pending claims for the refund of its input VAT for the period 1989 to 1991, amounting to a significant sum. Philex argued that the BIR should apply the amount of its refund claims against the deficiency excise tax assessments, effectively offsetting its tax liabilities with its refund claims.

Issue:

Whether Philex Mining Corporation can offset its deficiency excise tax liabilities with its pending input VAT refund claims.

Ruling:

The Supreme Court ruled against Philex Mining Corporation, holding that taxes cannot be the subject of set-off or compensation. The Court based its decision on several grounds:

• Nature of Tax Obligations: Taxes are the lifeblood of the government, essential for its existence and operation. Allowing taxes to be subject to set-off or compensation would be detrimental to public interest as it would undermine the government's ability to generate revenue.
• Statutory Prohibition: Section 204 of the National Internal Revenue Code (NIRC)⁴ does not expressly prohibit compensation against tax liabilities. The Court rejected Philex’s proposed set-off under the principle that taxes generally cannot be compensated against claims against the government.
• Public Policy Consideration: Allowing set-off or compensation of tax liabilities against claims for tax refunds would create administrative and fiscal complications for the government. It would also encourage taxpayers to withhold tax payments, hoping to offset them against future claims, thus affecting the government's cash flow.
• Legal Precedents: The Court referred to previous rulings that consistently upheld the principle that taxes are not subject to set-off or compensation. In particular, the Court mentioned the case of Mambulao Lumber Company⁵, where it was ruled that a tax liability cannot be extinguished by a claim for a refund against the government.
• Equity and Good Conscience: Philex’s argument that equity and good conscience should allow for the set-off was dismissed by the Court. The Court emphasized that equitable considerations cannot override the clear provisions of the law, especially when public policy is at stake.

Commissioner of Internal Revenue v. Firestone Ceramics, Inc., G.R. No. 167274⁶: The Supreme Court held that tax liabilities cannot be the subject of set-off or legal compensation against any alleged claims against the government.

Philex Mining Corporation v. CIR, G.R. No. 148187, 16 April 2008⁷: The Court held that advances made as investments in a partnership, rather than loans, could not be deducted as bad debts. This ruling concerns bad-debt deductions, not the prohibition on setting off tax liabilities against refund claims.

Taxes are not subject to set-off or compensation for the following reasons:

• Taxes are of distinct kind, essence and nature, and these impositions cannot be classed in merely the same category as ordinary obligations;
• The applicable laws and principles governing each are peculiar, not necessarily common, to each other; and
• Public policy is better subserved if the integrity and independence of taxes are maintained. (Mambulao Lumber Company)

A person cannot refuse to pay tax on the basis that the government owes him an amount equal to or greater than the tax being collected. The collection of a tax cannot await the results of a lawsuit against the government. (Philex Mining Corporation v. CIR, G.R. No. 125704, 28 August 1998⁸; Francia v. INTERMEDIATE APPELLATE COURT and HO FERNANDEZ, G.R. No. L-67649, 28 June 1988⁹)

In several cases, as an exception to offsetting, the Court have allowed the determination of the taxpayer’s liability in a refund case, thereby allowing the offsetting taxes. In these cases, offsetting was allowed because the determination of the taxpayer’s liability is intertwined with the resolution for the claim of refund.

In the case of TPC, where in it filed a claim for refund or credit under Sec. 112 of the NIRC¹⁰ while the issue to be resolved is whether TPC is entitled of its unutilized input VAT, the Court did not need to determine any deficiency VAT to resolve the refund claim. The Court held that, since it is not a claim for refund under Section 229 of the NIRC¹¹, the correctness of TPC's VAT returns is not an issue. Hence, the determination of the taxpayer’s liability was not related with the resolution of the claim for refund or credit; the Court did not decide whether any tax liability could be set off. (CIR v. Toledo Power Company, G.R. No. 196415, 2 December 2015¹²)