tax week 8 digests

7/28/2019 TAX Week 8 Digests

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6. Improperly Accumulated Earnings Tax

CYANAMID PHILIPPINES, INC., petitioner,

vs.

THE COURT OF APPEALS, THE COURT OF TAX APPEALS and COMMISSIONER OF

INTERNAL REVENUE,respondent.

Date: Jan. 20, 2000

QUISUMBING,J.:

Petitioner, Cyanamid Philippines, Inc., a corporation organized under Philippine laws, is

a wholly owned subsidiary of American Cyanamid Co. based in Maine, USA. It is engaged

in the manufacture of pharmaceutical products and chemicals, a wholesaler of imported

finished goods, and an importer/indentor.

February 7, 198 - CIR sent an assessment letter to Cyanamid and demanded the payment

of deficiency income tax of P119,817.00 for taxable year 1981

Net income disclosed by the return as audited 14,575,210.00

Add: Discrepancies:

Professional fees/yr. 17018 261,877.00

per investigation 110,399.37

Total Adjustment 152,477.00

Net income per Investigation 14,727,687.00

Less: Personal and additional exemptions

Amount subject to tax 14,727,687.00

Income tax due thereon . . . 25% Surtax 2,385,231.50 3,237,495.00

Less: Amount already assessed 5,161,788.00

BALANCE 75,709.00

monthly interest from 1,389,639.00 44,108.00

Compromise penalties

TOTAL AMOUNT DUE 3,774,867.50 119,817.003

Cyamid protested the assessments particularly, (1) the 25% Surtax Assessment of

P3,774,867.50; (2) 1981 Deficiency Income Assessment of P119,817.00; and 1981

Deficiency Percentage Assessment of P8,846.72. Petitioner, it through external

accountant SGV claimed, among others, that the surtax for the undue accumulation of

earnings was not proper because the said profits were retained to increase

petitioner's working capital and it would be used for reasonable business needs of the

company. Petitioner contended that it availed of the tax amnesty under Executive

Order No. 41, hence enjoyed amnesty from civil and criminal prosecution granted by

the law.

CIR refused to allow the cancellation of the assessment notices

Petitioner appealed to the CTA. During the pendency of the case, however, both

parties agreed to compromise the 1981 deficiency income tax assessment of

P119,817.00. Petitioner paidP26,577 as compromise. But, surtax on improperly

accumulated profits remained unresolved.

Petitioner claimed that CIR's assessment representing the 25% surtax on its

accumulated earnings for the year 1981 had no legal basis because:

(a) petitioner accumulated its earnings and profits for reasonable business

requirements to meet working capital needs and retirement of indebtedness;

(b) petitioner is a wholly owned subsidiary of American Cyanamid Company, a

corporation organized under the laws of the State of Maine, USA, whose shares of

stock are listed and traded in New York Stock Exchange. This being the case, no

individual shareholder income taxes by petitioner's accumulation of earnings and

profits, instead of distribution of the same.

CTA denied petition. CA affirmed CTA

Issue: WHETHER THE RESPONDENT COURT ERRED IN HOLDING THAT THE

CYANAMID IS LIABLE FOR THE ACCUMULATED EARNINGS TAX FOR THE YEAR 1981.

Held: YES. CA and CTA affirmed

Sec. 25 of the old National Internal Revenue Code of 1977 states:

Sec. 25.Additional tax on corporation improperly accumulating profits or

surplus

(a) Imposition of tax. If any corporation is formed or availed of for the

purpose of preventing the imposition of the tax upon its shareholders or

members or the shareholders or members of another corporation, through

the medium of permitting its gains and profits to accumulate instead of being

divided or distributed, there is levied and assessed against such corporation,for each taxable year, a tax equal to twenty-five per-centum of the
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undistributed portion of i ts accumulated profits or surplus which shall be in

addition to the tax imposed by section twenty-four, and shall be computed,

collected and paid in the same manner and subject to the same provisions of

law, including penalties, as that tax.

(b) Prima facie evidence. The fact that any corporation is mere holding

company shall be prima facieevidence of a purpose to avoid the tax upon its

shareholders or members. Similar presumption will lie in the case of an

investment company where at any time during the taxable year more than

fifty per centum in value of its outstanding stock is owned, directly or indirectly,by one person.

(c) Evidence determinative of purpose. The fact that the earnings or profits of

a corporation are permitted to accumulate beyond the reasonable needs of the

business shall be determinative of the purpose to avoid the tax upon its

shareholders or members unless the corporation, by clear preponderance of

evidence, shall prove the contrary.

(d) Exception. The provisions of this sections shall not apply to banks, non-

bank financial intermediaries, corporation organized primarily, and authorized

by the Central Bank of the Philippines to hold shares of stock of banks,

insurance companies, whether domestic or foreign.

The provision discouraged tax avoidance through corporate surplus accumulation. When

corporations do not declare dividends, income taxes are not paid on the undeclared

dividends received by the shareholders. The tax on improper accumulation of surplus is

essentially a penalty tax designed to compel corporations to distribute earnings so that

the said earnings by shareholders could, in turn, be taxed.

A review of American taxation history on accumulated earnings tax will show that the

application of the accumulated earnings tax to publicly held corporations has beenproblematic. Initially, the Tax Court and the Court of Claims held that the accumulated

earnings tax applies to publicly held corporations. Then, the Ninth Circuit Court of

Appeals ruled in GolcondaMining v. Commissioner thatthe accumulated earnings tax

could only apply to closely held corporations. Despite Golconda, the Internal RevenueService asserted that the tax could be imposed on widely held corporations including

those not controlled by a few shareholders or groups of shareholders. The Service

indicated it would not follow the Ninth Circuit regarding publicly held corporations. In

1984, American legislation nullified the Ninth Circuit's Golconda ruling and made it clear

that the accumulated earnings tax is not limited to closely held corporations. Golconda is

no longer a reliable precedent.

The amendatory provision of Section 25 of the 1977 NIRC, which was PD 1739,

enumerated the corporations exempt from the imposition of improperly accumulated

tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d)

corporations organized primarily and authorized by the Central Bank of the Philippines

to hold shares of stocks of banks. Petitioner does not fall among those exempt cl asses.

Besides, the rule on enumeration is that the express mention of one person, thing, act, orconsequence is construed to exclude all others. Laws granting exemption from tax are

construed strictissimi juris against the taxpayer and liberally in favor of the taxing

power. Taxation is the rule and exemption is the exception. The burden of proof rests

upon the party claiming exemption to prove that it is, in fact, covered by the

exemption so claimed, a burden which petitioner here has failed to discharge.

Another point raised by the petitioner in objecting to the assessment, is that increase

of working capital by a corporation justifies accumulating income. Petitioner asserts

that respondent court erred in concluding that Cyanamid need not infuse additional

working capital reserve because it had considerable liquid funds based on the 2.21:1

ratio of current assets to current liabilities. Petitioner relies on the so-called "Bardahl"formula, which allowed retention, as working capital reserve, sufficient amounts of

liquid assets to carry the company through one operating cycle. The "Bardahl" formula

was developed to measure corporate liquidity. The formula requires an examination

of whether the taxpayer has sufficient liquid assets to pay all of its current liabilities

and any extraordinary expenses reasonably anticipated, plus enough to operate the

business during one operating cycle. Operating cycle is the period of time it takes to

convert cash into raw materials, raw materials into inventory, and inventory into

sales, including the time it takes to collect payment for the sales.

Petitioner contends, Cyanamid needed at least P33,763,624.00 pesos as working

capital. As of 1981, its liquid asset was only P25,776,991.00. Thus, petitioner asserts

that Cyanamid had a working capital deficit of P7,986,633.00. Therefore, the

P9,540,926.00 accumulated income as of 1981 may be validly accumulated to increasethe petitioner's working capital for the succeeding year.

We note, however, that the companies where the "Bardahl" formula was applied, had

operating cycles much shorter than that of petitioner. As stressed by American

authorities, although the "Bardahl" formula is well-established and routinely applied

by the courts, it is not a precise rule. It is used only for administrative convenience.

Petitioner's application of the "Bardahl" formula merely creates a false illusion of

exactitude.

Other formulas are also used, e.g. the ratio of current assets to current liabilities and

the adoption of the industry standard. The ratio of current assets to current liabilities

is used to determine the sufficiency of working capital. Ideally, the working capitalshould equal the current liabilities and there must be 2 units of current assets for

every unit of current liability, hence the so-called "2 to 1" rule.

As of 1981 the working capital of Cyanamid was P25,776,991.00, or more than twice

its current liabilities. That current ratio of Cyanamid, therefore, projects adequacy in

working capital. Said working capital was expected to increase further when more

funds were generated from the succeeding year's sales. Available income covered

expenses or indebtedness for that year, and there appeared no reason to expect an

impending "working capital deficit" which could have necessitated an increase inworking capital, as rationalized by petitioner.

If the CIR determined that the corporation avoided the tax on shareholders by

permitting earnings or profits to accumulate, and the taxpayer contested such adetermination, the burden of proving the determination wrong, together with the


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corresponding burden of first going forward with evidence, is on the taxpayer. This

applies even if the corporation is not a mere holding or investment company and does

not have an unreasonable accumulation of earnings or profits.27

In order to determine whether profits are accumulated for the reasonable needs to avoid

the surtax upon shareholders, it must be shown that the controlling intention of the

taxpayer is manifest at the time of accumulation, not intentions declared subsequently,

which are mere afterthoughts. Furthermore, the accumulated profits must be used

within a reasonable time after the close of the taxable year. In the instant case, petitioner

did not establish, by clear and convincing evidence, that such accumulation of profit wasfor the immediate needs of the business.

In the present case, the Tax Court opted to determine the working capital sufficiency by

using the ratio between current assets to current liabilities. The working capital needs of

a business depend upon nature of the business, its credit policies, the amount of

inventories, the rate of the turnover, the amount of accounts receivable, the collection

rate, the availability of credit to the business, and similar factors. Petitioner, by adhering

to the "Bardahl" formula, failed to impress the tax court with the required definiteness

envisioned by the statute. We agree with the tax court that the burden of proof to

establish that the profits accumulated were not beyond the reasonable needs of the

company, remained on the taxpayer. This Court will not set aside lightly the conclusion

reached by the Court of Tax Appeals which, by the very nature of its function, is

dedicated exclusively to the consideration of tax problems and has necessarily developedan expertise on the subject, unless there has been an abuse or improvident exercise of

authority. Unless rebutted, all presumptions generally are indulged in favor of the

correctness of the CIR's assessment against the taxpayer. With petitioner's failure to

prove the CIR incorrect, clearly and conclusively, this Court is constrained to uphold the

correctness of tax court's ruling as affirmed by the Court of Appeals.

Petition Denied

Bellosillo, Mendoza, Buena and De Leon, Jr., JJ., concur.

-Justin

D. EXEMPT ENTITIES

2. Co-ownership

OBILLOS v. CIR and CTA

(Oct 29, 1985)

DOCTRINE: Article 1769(3) of the Civil Code provides that "the sharing of gross returns

does not of itself establish a partnership, whether or not the persons sharing them have a

joint or common right or interest in any property from which the returns are derived".

There must be an unmistakable intention to form a partnership or joint venture.

NATURE: Instant Appeal

PONENTE: Aquino

FACTS:

1. March 2, 1973. Jose Obillos, Sr. completed payment to Ortigas & Co., Ltd. ontwo lots located at Greenhills, San Juan, Rizal. The next day he transferred his

rights to his four children, the petitioners, to enable them to build their

residences.

2. The company sold the two lots to petitioners for P178,708.12 on March 13.Presumably, the Torrens titles issued to them would show that they were co-owners of the two lots.

3. In 1974, or after having held the two lots for more than a year, thepetitioners resold them to the Walled City Securities Corporation and Olga

Cruz Canda for the total sum of P313,050. They derived from the sale a total

profit of P134,341.88 or P33,584 for each of them. They treated the profit

as a capital gain and paid an income tax on one-half thereof or of

P16,792.

4. In April, 1980, or one day before the expiration of the five-year prescriptiveperiod, the Commissioner of Internal Revenue required the fourpetitioners to pay corporate income tax on the total profit of P134,336

in addition to individual income tax on their shares thereof. He assessedP37,018 as corporate income tax, P18,509 as 50% fraud surcharge and

P15,547.56 as 42% accumulated interest, or a total of P71,074.56.

a. He also considered the share of the profits of each petitioner inthe sum of P33,584 as a " taxable in full (not a mere capital

gain of which is taxable) and required them to pay

deficiency income taxes aggregating P56,707.20 including the

50% fraud surcharge and the accumulated interest.

5. In sum, the petitioners were held liable for deficiency income taxes andpenalties totalling P127,781.76 on their profitof P134,336, in addition to

the tax on capital gains already paid by them.a. The Commissioner acted on the theory that the four

petitioners had formed an unregistered partnership or joint

venture within the meaning of sections 24(a) and 84(b) of the

Tax Code.

6. The petitioners contested the assessments. Two Judges of the Tax Courtsustained the same. Judge Roaquin dissented. Hence, the instant appeal.

ISSUE:

1. WON petitioners formed a partnership or joint venture. NORATIO: Petitioners did not form a partnership or joint venture

1. NO INTENTION TO FORM PARTNERSHIPTo regard the petitioners as having formed a taxable unregistered partnership underArt. 1767 NCCsimply because they allegedly contributed money to buy the two lots,
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resold the same and divided the profit among themselveswould result in oppressive

taxation.

As testified by Jose Obillos, Jr., they had no such intention. They were co-owners pure

and simple. To consider them as partners would obliterate the distinction between

a co-ownership and a partnership. The petitioners were not engaged in any joint

venture by reason of that isolated transaction.

Their original purpose was to divide the lots for residential purposes. If later on

they found it not feasible to build their residences on the lots because of thehigh cost of construction, then they had no choice but to resell the same to

dissolve the co-ownership. The division of the profit was merely incidental to

the dissolution of the co-ownership which was in the nature of things a

temporary state. It had to be terminated sooner or later.

Article 1769(3) of the Civil Code provides that "the sharing of gross returns does not of

itself establish a partnership, whether or not the persons sharing them have a joint or

common right or interest in any property from which the returns are derived". There

must be an unmistakable intention to form a partnership or joint venture.

See Gatchalian vs. Collector of Internal Revenue where 15 persons contributedsmall amounts to purchase a two-peso sweepstakes ticket with the agreement

that they would divide the prize The ticket won the third prize of P50,000. The15 persons were held liable for income tax as an unregistered partnership.

The instant case is distinguishable from the cases where the parties engaged in joint

ventures for profit.

2. ALL CO-OWNERSHIPS ARE NOT AUTOMATICALLY DEEMED UNREGISTEREDPARTNERSHIPS

The Commissioner has even based its ruling on the following CTA Decisions:

Co-Ownership who own properties which produce income should not

automatically be considered partners of an unregistered partnership, or acorporation, within the purview of the income tax law. To hold otherwise, would be

to subject the income ofall co-ownerships of inherited properties to the tax on

corporations, inasmuch as if a property does not produce an income at all, it is not

subject to any kind of income tax, whether the income tax on individuals or the income

tax on corporation. De Leon v. CIR, CTA case

See Longa v. Aranas, CTA case: The Longa heirs inherited the 'hacienda' in

question pro-indiviso from their deceased parents; they did not contribute or

invest additional ' capital to increase or expand the inherited properties; they

merely continued dedicating the property to the use to which it had been put

by their forebears; they individually reported in their tax returns their

corresponding shares in the income and expenses of the 'hacienda', and they

continued for many years the status of co-ownership in order, as conceded by

respondent, 'to preserve its value and to continue the existing contractual

relations.

3. WHEN CO-OWNERSHIP MAY BECOME AN UNREGISTERED PARTNERSHIPWhere after an extrajudicial settlement the co-heirs used the inheritance or the

incomes derived therefrom as a common fund to produce profits for themselves,

it was held that they were taxable as an unregistered partnership.

In the following cases, the SC held that petitioners had an unregistered partnership:

Reyes vs. Commissioner of Internal Revenue: where father and son purchased

a lot and building, entrusted the administration of the building to anadministrator and divided equally the net income,

Evangelista vs. Collector of Internal Revenue: where the three Evangelista

sisters bought four pieces of real property which they leased to various

tenants and derived rentals therefrom.

In the instant case, what the Commissioner should have investigated was whether the

father donated the two lots to the petitioners and whether he paid the donor's tax (See

Art. 1448, Civil Code). We are not prejudging this matter. It might have already

prescribed.

DISPOSITION: WHEREFORE, the judgment of the Tax Court is reversed and set aside.

The assessments are cancelled. No costs.VOTING: 2nd Division. 4 concur. 1 on leave

-Jenin

3. Section 30, NIRC

THE COLLECTOR OF INTERNAL REVENUE v V. G. SINCO EDUCATIONAL

CORPORATION

(October 23, 1956)

Doctrine:

1. Whatever payment is made to those who work for a school or college as aremuneration for their services is not considered as distribution of profit aswould make the school one conducted for profit.

2. Appellee charges tuition fees and other fees for the different services itrenders to the students and in fact it is its only source of income, but such

fact does not in itself make the school a profit-making enterprise that would

place it beyond the purview of the law.

3. The amount of fees charged by a school x x x is not conclusive of thepurposes of the institution.

Ponente: BAUTISTA ANGELO,J

Nature: petition for review on certiorari of a decision of the CTA.

Facts:

- Vicente G. Sinco established and operated an educational institution knownas Foundation College of Dumaguete On September 21, 1951, the V. G. Sinco


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Educational Institution was organized. This corporation was non-stock and was

capitalized by V. G. Sinco and members of his immediate family. This

corporation continued the operations of Foundation College of Dumaguete.

- The Collector of Internal Revenue assessed against the college an income tax forthe years 1950 and 1951 in the aggregate sum of P5,364.77, which was paid by

the college.

- Two years thereafter, the corporation commenced an action in the Court ofFirst Instance of Negros Oriental for the refund of this amount alleging that it is

exempt from income tax under section 27 (e) of the National Internal Revenue

Code.- CTA decided in favor of Sinco.

Petitioners:

1. Part of the net income accumulated by theAppellee inured to the benefit of V. G.Sinco, president and founder of the corporation, and therefore the Appellee is

not entitled to the exemption prescribed by the law.

a. Looking at the balance sheets of the school, Appellantclaims that agreat portion of the net profits realized by the corporation was

channeled and redounded to the personal benefit of V. G. Sinco, who

was its founder and president.

b. Another benefit that accrued to Sinco is represented by the severalamounts which appear payable to the Community Publishers, Inc.

because, being the biggest stockholder of this entity, the money to bepaid by theAppellee to that entity as appearing in the above quoted

entries would redound to the personal benefit of Sinco.

Respondent:

1. It is exempt from the payment of the income tax because it is organized andmaintained exclusively for the educational purposes and no part of its net

income inures to the benefit of any private individual.

Issues:

Sub-issue: Is VG Sinco an educational institution in which part of its income inures to the

benefit of one of its stockholders?

Main Issue: Is VG Sinco Corp liable for income tax?

Held & Ratio:

Sub-issue:

No. Dean Sinco made the following clarification:chanroblesvirtuallawlibraryHe acted as

president of the Foundation College and as chairman of its Board of Directors; chan

roblesvirtualawlibraryin 1949 he served as its teacher for a time; chan

roblesvirtualawlibrarythe accountant of the college suggested that a certain amount be

set aside as his salary for purposes of orderly and practical accounting; chan

roblesvirtualawlibrarybut notwithstanding this suggestion, he never collected his salary

for which reason it was carried in the books as accrued expenses. With regard to theaccount of the Community Publishers, Inc., Sinco said that this is a distinct and separate

corporation although he is one of its stockholders. The account represents payment for

services rendered by this entity to the college. These are two different entities andwhatever relation there is between the two is that the former merely extends help to the

latter to enable it to comply with the requirements of the law and to fill its needs for

educational purposes. This clarification made by Sinco stand undisputed.

Main Issue:

It is indeed too sweeping if not unfair to conclude that part of the income of

theAppellee as an institution inured to the benefit of one of its stockholders simply

because part of the income was carried in its books as accumulated salaries of its

president and teacher. Much less can it be said that the payments made by the collegeto the Community Publishers, Inc. redounded to the personal benefit of Sinco simply

because he is one of its stockholders. The fact is that, as it has been established,theAppellee is a non-profit institution and since its organization it has never

distributed any dividend or profit to its stockholders. Of course, part of its income

went to the payment of its teachers or professors and to the other expenses of the

college incident to an educational institution but none of the income has ever been

channeled to the benefit of any individual stockholder. The authorities are clear to the

effect that whatever payment is made to those who work for a school or college as a

remuneration for their services is not considered as distribution of profit as would

make the school one conducted for profit.

Mayor and Common Council of Borough of Princeton vs. State Board of Taxes &

Assessments, et al., 115 Atl., 342: school is not conducted for profit merely because

moderate salaries were paid to the principal and to the teachers.

Of course, it is not denied that theAppellee charges tuition fees and other fees for thedifferent services it renders to the students and in fact it is its only source of income,

but such fact does not in itself make the school a profit-making enterprise that would

place it beyond the purview of the law.

Jesus Sacred Heart College vs. Collector of Internal Revenue, 95 Phil., 16:

Needless to say, every responsible organization must be so run as to, at least, insure

its existence, by operating within the limits of its own resources, especially its regular

income. In other words, it should always strive, whenever possible, to have a surplus.

Again, the amount of fees charged by a school, college or university depends,

ultimately, upon the policy and a given administration, at a particular time. It is not

conclusive of the purposes of the institution. Otherwise, such purpose would vary with

the particular persons in charge of the administration of the organization.

CIR Argues: Appellee is not entitled to the exemption of the law because of the use

made by it of part of its income in acquiring additional buildings and equipment,

saying that the property of the corporation may be sold at any time and the profits

thereof divided among the stockholders or members.

This claim is too speculative. It has been held by several authorities that the mere

provision for the distribution of its assets to the stockholders upon dissolution does

not remove the right of an educational institution from tax exemption. In U. S. vs.

Picwick Electric Membership Corp., 158 F. 2d 272, 277, it was held The fact that

the members may receive some benefit on dissolution upon distribution of the assets

is a contingency too remote to have any material bearing upon the question where the

association is admittedly not a scheme to avoid taxation and its good faith and honesty

or purpose is not challenged.


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Dispositive:

Decision appealed from affirmed.

Vote: Paras, C.J., Padilla, Montemayor, Labrador, Concepcion, Reyes, J. B. L., Endencia and

Felix,JJ., concur.

-Wiggy

G. ITEMS OF GROSS INCOME

i. Convenience-of-the-employer rule

Henderson v. Collector of Internal Revenue Sandra

H. INTEREST INCOME

3. Imputed interest on inter-company loans/Advances

Commissioner of Internal Revenu vs. Filinvest Development Corporation

(July 19, 2011)

Ponente: Perez

RATIO: There must be proof of the actual or, at the very least, probable receipt or

realization by the controlled taxpayer of the item of gross income sought to be

distributed, apportioned or allocated by the CIR.

FACTS: [simple enough]

1. Filinvest Development Corporation (FDC) owned 80% of the outstandingshares of Filinvest Alabang, Inc. (FAI) and is also a holding company which

owned 67.82% of the outstanding shares of Filinvest Land, Inc. (FLI)

a. FDC and FAI entered into a DEED OF EXCHANGE with FLI where FDCand FAI both transferred in favor of FLI parcels of land in exchange for

shares of stock of FLI. The result of this was FDC owned 61.03% of

FLIs shares of stock, FAI owned 9.96% and the rest were owned by

others.

b. Later, FLI requested a ruling from the BIR to the effect that no gain orloss should be recognized in the aforesaid transfer of real properties.

c. BIR found that the exchange was among those contemplated underSection 34(c)(2) of the NIRC, which provides that:

No gain or loss shall be recognized if property is

transferred to a corporation by a person in exchange

for a stock in such corporation of which as a result of

such exchange said person, alone or together with

others, not exceeding four (4) persons, gains control

of said corporation.

2. Between 1996 and 1997, FDC also extended cash advances in favor of itsaffiliates.

a. On 15 November 1996, FDC also entered into a ShareholdersAgreement with Reco Herrera PTE Ltd. (RHPL) for the formation of

a Singapore-based joint venture company called Filinvest Asia

Corporation (FAC).

b. With their equity participation in FAC respectively pegged at 60%and 40% in the Shareholders Agreement, FDC subscribed

to P500.7 million worth of shares in said joint venture company to

RHPLs subscription worth P433.8 million.

c. Having paid its subscription by executing a Deed of Assignmenttransferring to FAC a portion of its rights and interest in the Project

worth P500.7 million, FDC eventually reported a net loss

of P190,695,061.00 in its Annual Income Tax Return for the taxable

year 1996.

3. On 3 January 2000, FDC received from the BIR a Formal Notice of Demand topay deficiency income and documentary stamp taxes, plus interests and

compromise penalties.

a. The foregoing deficiency taxes were assessed on the taxable gainsupposedly realized by FDC from the Deed of Exchange it executed

with FAI and FLI, on the dilution resulting from the Shareholders

Agreement FDC executed with RHPL as well as the arms -length

interest rate and documentary stamp taxes imposable on the

advances FDC extended to its affiliates.

b.

FAI similarly received from the BIR a Formal Letter of Demand fordeficiency income taxes in the sum of P1,477,494,638.23 for the


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year 1997, which was also assessed on the taxable gain purportedly

realized by FAI from the Deed of Exchange it executed with FDC and

FLI.

c. FDC and FAI filed their respective requests forreconsideration/protest, on the ground that the deficiency income

and documentary stamp taxes assessed by the BIR were bereft of

factual and legal basis

4. In view of the failure of petitioner Commissioner of Internal Revenue (CIR) toresolve their request for reconsideration/protest within the aforesaid period,

FDC and FAI filed on 17 October 2000 a petition for review with the Court of

Tax Appeals (CTA) pursuant to Section 228 of the 1997 NIRC.

a. The petition alleged:i. that as previously opined in BIR Ruling No. S-34-046-97, no

taxable gain should have been assessed from the subject

Deed of Exchange since FDC and FAI collectively gained

further control of FLI as a consequence of the exchange;

ii. that correlative to the CIR's lack of authority to imputetheoretical interests on the cash advances FDC extended in

favor of its affiliates, the rule is settled that interests cannot

be demanded in the absence of a stipulation to the effect;

iii. that not being promissory notes or certificates of obligations,the instructional letters as well as the cash and journal

vouchers evidencing said cash advances were not subject to

documentary stamp taxes; and,

iv. that no income tax may be imposed on the prospective gainfrom the supposed appreciation of FDC's shareholdings in

FAC.

5. CIR filed its answer, claiming that the transfer of property in question shouldnot be considered tax free since, with the resultant diminution of its shares in

FLI, FDC did not gain further control of said corporation.

a.

CIR invoked Section 43 of the old NIRC which, as implemented byRevenue Regulations No. 2, Section 179 (b) and (c), gave him "the

power to allocate, distribute or apportion income or deductions

between or among such organizations, trades or business in order to

prevent evasion of taxes."

b. The CIR justified the imposition of documentary stamp taxes on theinstructional letters as well as cash and journal vouchers for said

cash advances on the strength of Section 180 of the NIRC and

Revenue Regulations No. 9-94 which provide that loantransactions are subject to said tax irrespective of whether or not

they are evidenced by a formal agreement or by mere office memo.

c. The CIR also argued that FDC realized taxable gain arising from thedilution of its shares in FAC as a result of its Shareholders'

Agreement with RHPL.

6. CTA went on to render the Decision dated 10 September 2002 which, withthe exception of the deficiency income tax on the interest income FDC

supposedly realized from the advances it extended in favor of its affiliates,

cancelled the rest of deficiency income and documentary stamp taxes

assessed against FDC and FAI for the years 1996 and 1997.

a. CTA also ruled that the increase in the value of FDC's shares in FACdid not result in economic advantage in the absence of actual sale

or conversion thereof.

b. While likewise finding that the documents evidencing the cashadvances FDC extended to its affiliates cannot be considered as loan

agreements that are subject to documentary stamp tax, the CTA

enunciated, however, that the CIR was justified in assessing

undeclared interests on the same cash advances pursuant to his

authority under Section 43 of the NIRC in order to forestall tax

evasion.

7. FDC filed on 5 November 2002 the petition for review.a. Calling attention to the fact that the cash advances it extended to its

affiliates were interest-free in the absence of the express

stipulation on interest required under Article 1956 of the Civil Code,FDC questioned the imposition of an arm's-length interest rate


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thereon on the ground, among others, that the CIR's authority under

Section 43 of the NIRC:

i. does not include the power to impute imaginary interest onsaid transactions;

ii. is directed only against controlled taxpayers and not againstmother or holding corporations; and,

iii.

can only be invoked in cases of understatement of taxablenet income or evident tax evasion.

b. Upholding FDC's position, CA reversed and set aside the CTA decisionand entered a new one annulling the assessment imposing deficiency

income tax on FDC

8. CIR also filed the petition for review docketed before the CA, arguing that theCTA reversibly erred in cancelling the assessment notices. The petition was,

however, denied due course and dismissed for lack of merit in the herein

assailed decision dated 26 January 2005.

a. CIR then filed for petition for review on certiorari of the 16 December2003 decision in and the 26 January 2005 decision, which were

respectively docketed as G.R. Nos. 163653 and 167689. These two

petitions were then consolidated.

b. In G.R. No. 163653, the CIR urges the grant of its petition on thefollowing ground:

i. CA erred in holding that the cash advances extended byrespondent to it affiliates were not subject to income tax.

c. In G.R. No. 167689, on the other hand, petitioner proffers thefollowing issues for resolution:

i. CA committed grave abuse of discretion in holding that theexchange of share of stock for property among FDC, FAI and

FLI met all the requirements for non-recognition of taxable

gain under Section 32(c)(2) of the old NIRC, now Section 40

(C)(2)(c) of the current NIRC.

ii. CA erred in holding that the letters of instruction or cashvouchers extended by FDC to its affiliates are not deemed

loan agreements subject to documentary stamp taxes underSection 180 of NIRC

iii. CA erred in holding that the gain on dilution as a result ofthe increase in the value of FDCs shareholdings in FAC is

not taxable.

RATIO: [whadafuqisdissheet]

1. [WHAT IS NEEDED IN CLASS] In G.R. No. 163653, the CIR argues that the CAerred in reversing the CTAs finding that theoretical interests can be imputed

on the advances FDC extended to its affiliates in 1996 and 1997 considering

that, for said purpose, FDC resorted to interest-bearing fund borrowings

from commercial banks.

a. Since considerable interest expenses were deducted by FDC whensaid funds were borrowed, CIR theorizes that interest income

should likewise be declared when the same funds were sourced for

the advances FDC extended to its affiliates.

b. Invoking Section 43 of the 1993 NIRC in relation to Section179(b) of Revenue Regulation No. 2, the CIR maintains that it is

vested with the power to allocate, distribute or apportion income

or deductions between or among controlled organizations, trades

or businesses even in the absence of fraud, since said power is

intended to prevent evasion of taxes or clearly to reflect the income

of any such organizations, trades or businesses.

c. CIR asseverates that the CA should have accorded weight andrespect to the findings of the CTA which, as the specialized court

dedicated to the study and consideration of tax matters, can take

judicial notice of US income tax laws and regulations.

2. Section 43 of the 1993 NIRC provides that:In any case of two or more organizations, trades or businesses

(whether or not incorporated and whether or not organized in

the Philippines) owned or controlled directly or indirectly by

the same interests, the Commissioner of Internal Revenue isauthorized to distribute, apportion or allocate gross income or


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deductions between or among such organization, trade or

business, if he determines that such distribution,

apportionment or allocation is necessary in order to prevent

evasion of taxes or clearly to reflect the income of any such

organization, trade or business.

a. As may be gleaned from the definitions of the terms controlled and

"controlled taxpayer" under paragraphs (a) (3) and (4) of Sec. 179(b)

of Revenue Regulation No. 2, it would appear that FDC and its

affiliates come within the purview of Section 43 of the 1993 NIRC.

b. Aside from owning significant portions of the shares of stock of FLI,FAI, DSCC and FCI, the fact that FDC extended substantial sums of

money as cash advances to its said affiliates for the purpose of

providing them financial assistance for their operational and capital

expenditures seemingly indicate that the situation sought to be

addressed by the subject provision exists.

c. From the tenor of paragraph (c) of Section 179 of Revenue RegulationNo. 2, it may also be seen that the CIR's power to distribute, apportion

or allocate gross income or deductions between or among controlled

taxpayers may be likewise exercised whether or not fraud inheres in

the transaction/s under scrutiny.

d. For as long as the controlled taxpayer's taxable income is notreflective of that which it would have realized had it been dealing at

arm's length with an uncontrolled taxpayer, the CIR can make the

necessary rectifications in order to prevent evasion of taxes.

3. SC finds that the CIR's powers of distribution, apportionment or allocation ofgross income and deductions under Section 43 of the 1993 NIRC and Section

179 of Revenue Regulation No. 2 does not include the power to impute

"theoretical interests" to the controlled taxpayer's transactions.

a. Pursuant to Section 28 of the 1993 NIRC, after all, the term grossincome is understood to mean all income from whatever

source derived, including, but not limited to the following items:

compensation for services, including fees, commissions, and similaritems; gross income derived from business; gains derived from

dealings in property; interest; rents; royalties; dividends;

annuities; prizes and winnings; pensions; and partners distributive

share of the gross income of general professional partnership.

b. While it has been held that the phrase "from whatever sourcederived" indicates a legislative policy to include all income not

expressly exempted within the class of taxable income under our

laws, the term "income" has been variously interpreted to mean"cash receivedor its equivalent", "the amount of money coming to a

person within a specific time" or "something distinct from principal

or capital."

c. Otherwise stated, there must be proof of the actual or, at the veryleast, probable receipt or realization by the controlled taxpayer of

the item of gross income sought to be distributed, apportioned or

allocated by the CIR.

4. A perusal of the record yielded no evidence of actual or possible showingthat the advances FDC extended to its affiliates had resulted to the interests

subsequently assessed by the CIR.

a. For all its harping upon the supposed fact that FDC had resorted toborrowings from commercial banks, the CIR had adduced no

concrete proof that said funds were, indeed, the source of the

advances the former provided its affiliates.

b. While admitting that FDC obtained interest-bearing loans fromcommercial banks, Susan Macabelda - FDC's Funds Management

Department Manager who was the sole witness presented before

the CTA - clarified that the subject advances were sourced from the

corporation's rights offering in 1995 as well as the sale of its

investment in Bonifacio Land in 1997.

c. More significantly, said witness testified that said advances: (a)were extended to give FLI, FAI, DSCC and FCI financial assistance

for their operational and capital expenditures; and, (b) were all

temporarily in nature since they were repaid within the duration of

one week to three months and were evidenced by mere journal

entries, cash vouchers and instructional letters.


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5. Even if we were, therefore, to accord precipitate credulity to the CIR's bareassertion that FDC had deducted substantial interest expense from its gross

income, there would still be no factual basis for the imputation of theoretical

interests on the subject advances and assess deficiency income taxes thereon.

a. More so, when it is borne in mind that, pursuant to Article 1956 ofthe Civil Code of the Philippines, no interest shall be due unless it has

been expressly stipulated in writing.

b. Considering that taxes, being burdens, are not to be presumed beyondwhat the applicable statute expressly and clearly declares, the rule is

likewise settled that tax statutes must be construed strictly against

the government and liberally in favor of the taxpayer.

c. Accordingly, the general rule of requiring adherence to the letter inconstruing statutes applies with peculiar strictness to tax laws and the

provisions of a taxing act are not to be extended by implication.

d. While it is true that taxes are the lifeblood of the government, it hasbeen held that their assessment and collection should be in

accordance with law as any arbitrariness will negate the very reason

for government itself.

6. [EXTRANEOUS SHIZZ] In G.R. No. 167689, we also find a dearth of merit in theCIR's insistence on the imposition of deficiency income taxes on the transfer

FDC and FAI effected in exchange for the shares of stock of FLI. With respect to

the Deed of Exchange executed between FDC, FAI and FLI, Section 34 (c) (2) of

the 1993 NIRC pertinently provides as follows:

Sec. 34. Determination of amount of and

recognition of gain or loss.-

x x x x

(c) Exception x x x x

No gain or loss shall also be recognized if property is

transferred to a corporation by a person in exchange for

shares of stock in such corporation of which as a result of such

exchange said person, alone or together with others, not

exceeding four persons, gains control of said

corporation; Provided, That stocks issued for services shallnot be considered as issued in return of property.

7. As even admitted in the 14 February 2001 Stipulation of Facts submitted bythe parties, the requisites for the non-recognition of gain or loss under the

foregoing provision are as follows: (a) the transferee is a corporation; (b) the

transferee exchanges its shares of stock for property/ies of the transferor;

(c) the transfer is made by a person, acting alone or together with others, not

exceeding four persons; and, (d) as a result of the exchange the transferor,

alone or together with others, not exceeding four, gains control of the

transferee.

a. Acting on the 13 January 1997 request filed by FLI, the BIR had, infact, acknowledged the concurrence of the foregoing requisites in

the Deed of Exchange the former executed with FDC and FAI by

issuing BIR Ruling No. S-34-046-97.

b. With the BIR's reiteration of said ruling upon the request forclarification filed by FLI, there is also no dispute that said

transferee and transferors subsequently complied with the

requirements provided for the non-recognition of gain or loss from

the exchange of property for tax, as provided under Section 34 (c)

(2) of the 1993 NIRC.

8. Then as now, the CIR argues that taxable gain should be recognized for theexchange considering that FDC's controlling interest in FLI was actually

decreased as a result thereof.

a.

For said purpose, the CIR calls attention to the fact that, prior to theexchange, FDC owned 2,537,358,000 or 67.42% of FLI's

3,763,535,000 outstanding capital stock.

b. Upon the issuance of 443,094,000 additional FLI shares as aconsequence of the exchange and with only 42,217,000 thereof

accruing in favor of FDC for a total of 2,579,575,000 shares, said

corporations controlling interest was supposedly reduced to

61%.03 when reckoned from the transferee's aggregate

4,226,629,000 outstanding shares.

c. Without owning a share from FLI's initial 3,763,535,000outstanding shares, on the other hand, FAI's acquisition of


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420,877,000 FLI shares as a result of the exchange purportedly

resulted in its control of only 9.96% of said transferee corporation's

4,226,629,000 outstanding shares.

d. On the principle that the transaction did not qualify as a tax-freeexchange under Section 34 (c) (2) of the 1993 NIRC, the CIR

asseverates that taxable gain in the sum of P263,386,921.00 should be

recognized on the part of FDC and in the sum of P3,088,711,367.00 on

the part of FAI.[57]

9. The paucity of merit in the CIR's position is, however, evident from thecategorical language of Section 34 (c) (2) of the 1993 NIRC which provides

that gain or loss will not be recognized in case the exchange of property for

stocks results in the control of the transferee by the transferor, alone or with

other transferors not exceeding four persons.

a. Rather than isolating the same as proposed by the CIR, FDC's2,579,575,000 shares or 61.03% control of FLI's 4,226,629,000

outstanding shares should, therefore, be appreciated in combination

with the 420,877,000 new shares issued to FAI which represents

9.96% control of said transferee corporation.

b. Together FDC's 2,579,575,000 shares (61.03%) and FAI's420,877,000 shares (9.96%) clearly add up to 3,000,452,000 shares

or 70.99% of FLI's 4,226,629,000 shares.

c. Since the term "control" is clearly defined as "ownership of stocks in acorporation possessing at least fifty-one percent of the total voting

power of classes of stocks entitled to one vote" under Section 34 (c)

(6) [c] of the 1993 NIRC, the exchange of property for stocks between

FDC FAI and FLI clearly qualify as a tax-free transaction under

paragraph 34 (c) (2) of the same provision.

10. It also appears that the supposed reduction of FDC's shares in FLI posited bythe CIR is more apparent than real.

a. As the uncontested owner of 80% of the outstanding shares of FAI, itcannot be gainsaid that FDC ideally controls the same percentage of

the 420,877,000 shares issued to its said co-transferor which, by

itself, represents 7.968% of the outstanding shares of FLI.

b. Considered alongside FDC's 61.03% control of FLI as a consequenceof the 29 November 1996 Deed of Transfer, said 7.968% add up to

an aggregate of 68.998% of said transferee corporation's

outstanding shares of stock which is evidently still greater than the

67.42% FDC initially held prior to the exchange.

c. This much was admitted by the parties in the 14 February 2001Stipulation of Facts, Documents and Issues they submitted to the

CTA.

d. Inasmuch as the combined ownership of FDC and FAI of FLI'soutstanding capital stock adds up to a total of 70.99%, it stands to

reason that neither of said transferors can be held liable for

deficiency income taxes the CIR assessed on the supposed gain

which resulted from the subject transfer.

11. On the other hand, insofar as documentary stamp taxes on loan agreementsand promissory notes are concerned, Section 180 of the NIRC provides

follows:

Sec. 180. Stamp tax on all loan agreements,

promissory notes, bills of exchange, drafts, instruments

and securities issued by the government or any of its

instrumentalities, certificates of deposit bearing

interest and others not payable on sight or demand.On

all loan agreements signed abroad wherein the object of the

contract is located or used in the Philippines; bill of exchange

(between points within the Philippines), drafts, instruments

and securities issued by the Government or any of itsinstrumentalities or certificates of deposits drawing interest,

or orders for the payment of any sum of money otherwise than

at sight or on demand, or on all promissory notes, whether

negotiable or non-negotiable, except bank notes issued for

circulation, and on each renewal of any such note, there shall

be collected a documentary stamp tax of Thirty centavos

(P0.30) on each two hundred pesos, or fractional part thereof,

of the face value of any such agreement, bill of exchange, draft,

certificate of deposit or note: Provided, That only one

documentary stamp tax shall be imposed on either loan

agreement, or promissory notes issued to secure such loan,

whichever will yield a higher tax: Provided however, That

loan agreements or promissory notes the aggregate of whichdoes not exceed Two hundred fifty thousand pesos
http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn57http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn57http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn57http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn57


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(P250,000.00) executed by an individual for his purchase on

installment for his personal use or that of his family and not

for business, resale, barter or hire of a house, lot, motor

vehicle, appliance or furniture shall be exempt from the

payment of documentary stamp tax provided under this

Section.

a. When read in conjunction with Section 173 of the 1993 NIRC, theforegoing provision concededly applies to "(a)ll loan agreements,whether made or signed in the Philippines, or abroad when the

obligation or right arises from Philippine sources or the property or

object of the contract is located or used in the Philippines."

b. The terms 'Loan Agreement" under Section 180 and "Mortgage' underSection 195, both of the Tax Code, as amended, generally refer to

distinct and separate instruments. A loan agreement shall be taxed

under Section 180, while a deed of mortgage shall be taxed under

Section 195.

12. Applying the aforesaid provisions to the case at bench, we find that theinstructional letters as well as the journal and cash vouchers evidencing the

advances FDC extended to its affiliates in 1996 and 1997 qualified as loan

agreements upon which documentary stamp taxes may be imposed.

a. In keeping with the caveat attendant to every BIR Ruling to the effectthat it is valid only if the facts claimed by the taxpayer are correct, we

find that the CA reversibly erred in utilizing BIR Ruling No. 116-

98,dated 30 July 1998 which, strictly speaking, could be invoked only

by ASB Development Corporation, the taxpayer who sought thesame. In said ruling, the CIR opined that documents like those

evidencing the advances FDC extended to its affiliates are not subject

to documentary stamp tax.

b. CIR argued that the foregoing ruling was later modified in BIR RulingNo. 108-99 dated 15 July 1999, which opined that inter-office memos

evidencing lendings or borrowings extended by a corporation to its

affiliates are akin to promissory notes, hence, subject to documentary

stamp taxes.

c. In brushing aside the foregoing argument, however, the CA appliedSection 246 of the 1993 NIRC from which proceeds the settled

principle that rulings, circulars, rules and regulations promulgated

by the BIR have no retroactive application if to so apply them

would be prejudicial to the taxpayers.

d. Admittedly, this rule does not apply: (a) where the taxpayerdeliberately misstates or omits material facts from his return or in

any document required of him by the Bureau of Internal Revenue;

(b) where the facts subsequently gathered by the Bureau of

Internal Revenue are materially different from the facts on which

the ruling is based; or (c) where the taxpayer acted in bad faith.

e. Not being the taxpayer who, in the first instance, sought a rulingfrom the CIR, however, FDC cannot invoke the foregoing principle

on non-retroactivity of BIR rulings.

13. Viewed in the light of the foregoing considerations, we find that both the CTAand the CA erred in invalidating the assessments issued by the CIR for the

deficiency documentary stamp taxes due on the instructional letters as well

as the journal and cash vouchers evidencing the advances FDC extended to

its affiliates in 1996 and 1997.

a. In Assessment Notice No. SP-DST-96-00020-2000, the CIR correctlyassessed the sum of P6,400,693.62 for documentary stamp

tax, P3,999,793.44 in interests and P25,000.00 as compromise

penalty, for a total of P10,425,487.06. Alongside the sum

of P4,050,599.62 for documentary stamp tax, the CIR similarly

assessed P1,721,099.78 in interests and P25,000.00 as compromise

penalty in Assessment Notice No. SP-DST-97-00021-2000 or a total

of P5,796,699.40.

b. The imposition of deficiency interest is justified under Sec. 249 (a)and (b) of the NIRC which authorizes the assessment of the same

at the rate of twenty percent (20%), or such higher rate as may be

prescribed by regulations, from the date prescribed for the

payment of the unpaid amount of tax until full payment.

c. The imposition of the compromise penalty is, in turn, warrantedunder Sec. 250 of the NIRC which prescribes the imposition thereof

in case of each failure to file an information or return, statement or


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list, or keep any record or supply any information requ ired on the

date prescribed therefor.

14. To our mind, no reversible error can, finally, be imputed against both the CTAand the CA for invalidating the Assessment Notice issued by the CIR for the

deficiency income taxes FDC is supposed to have incurred as a consequence of

the dilution of its shares in FAC.

a. Alongside the principle that tax revenues are not intended to beliberally construed, the rule is settled that the findings and

conclusions of the CTA are accorded great respect and are generally

upheld by this Court, unless there is a clear showing of a reversible

error or an improvident exercise of authority.

b. Absent showing of such error here, we find no strong and cogentreasons to depart from said rule with respect to the CTA's finding that

no deficiency income tax can be assessed on the gain on the supposed

dilution and/or increase in the value of FDC's shareholdings in FAC

which the CIR, at any rate, failed to establish.

c. Bearing in mind the meaning of "gross income" as above discussed, itcannot be gainsaid, even then, that a mere increase or appreciation in

the value of said shares cannot be considered income for taxation

purposes.

d. Since a mere advance in the value of the property of a person orcorporation in no sense constitute the income specified in the

revenue law, it has been held in the early case ofFisher vs.

Trinidad,[74]that it constitutes and can be treated merely as an

increase of capital.

e. Hence, the CIR has no factual and legal basis in assessing income taxon the increase in the value of FDC's shareholdings in FAC until the

same is actually sold at a profit.

WHEREFORE, premises considered, the CIR's petition for review on certiorari in G.R. No.

163653 is DENIED for lack of merit and the CAs 16 December 2003 Decision in G.R. No.

72992 is AFFIRMED in toto. The CIRs petition in G.R. No. 167689 is PARTIALLY

GRANTED and the CAs 26 January 2005 Decision in CA-G.R. SP No. 74510 is MODIFIED.

a. Accordingly, Assessment Notices Nos. SP-DST-96-00020-2000 and SP-DST-97-00021-2000 issued for deficiency documentary stamp taxes due

on the instructional letters as well as journal and cash vouchers

evidencing the advances FDC extended to its affiliates are declared

valid.

b. The cancellation of Assessment Notices Nos. SP-INC-96-00018-2000, SP-INC-97-00019-2000 and SP-INC-97-0027-2000 issued for deficiency

income assessed on (a) the arms-length interest from said advances;

(b) the gain from FDCs Deed of Exchange with FAI and FLI; and (c)

income from the dilution resulting from FDCs Shareholders Agreement

with RHPL is, however, upheld.

[Love note: I am so, so sorry for how its almost as long as Rapunzels hair.]

-Jan

J. DIVIDEND INCOME

1. Kinds of dividends recognized in law

c. Stock

COMMISSIONER OF INTE RNAL REVENUE vs.MANNING

(August 6, 1975)

DOCTRINE:

- A stock dividend, being one payable in capital stock, cannot be declared out ofoutstanding corporate stock, but only from retained earnings.

- Nature of a stock dividend: A stock dividend always involves a transfer of surplus(or profit) to capital stock. A stock dividend is a conversion of surplus or undivided

profits into capital stock, which is distributed to stockholders in lieu of a cashdividend.

NATURE: Petition for Review

PONENTE: Castro

FACTS:

1. 1952 - Mantrasco had an authorized capital stock of P2.5M divided into25,000 common shares. 24,700 of these shares are owned by Julius Reese

while the rest, at 100 each, are owned by Manning, McDonald & Simmons.

2. February 29, 1958 - a trust agreement (see pp. 17-20 of the original) wasexecuted between Reese, Mantrasco, Ross, Selph, Carrascoso & Janda law

firm, Manning, McDonald and Simmons. Said agreement was entered into

because of Reeses desire thatMantrasco and Mantrasocs 2 subsidiaries,

Mantrasco Guam and Port Motors, to continue under the management of

Manning, McDonald and Simmons upon his [Reese] death.
http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn74http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn74http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn74http://sc.judiciary.gov.ph/jurisprudence/2011/july2011/163653.htm#_ftn74


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3. October 19, 1954 - Reese died. However, the projected transfer of his shares inthe name of Mantrasco could not be immediately effected for lack of sufficient

funds to cover the initial payment on the shares.

4. February 2, 1955 - after Mantrasco made a partial payment of Reese's shares,the certificate for the 24,700 shares in Reese's name was cancelled and a new

certificate was issued in the name of Mantrasco. Also, new certificate was

endorsed to the law firm of Ross, Selph, Carrascoso and Janda, as trustees for

and in behalf of Mantrasco.

5. December 22, 1958 - a resolution was passed during a special meeting ofMantrasco stockholders.6. November 25, 1963 - entire purchase price of Reese's interest in Mantrascowas finally paid in full by Mantrasco.

7. May 4, 1964 - trust agreement was terminated and the trustees delivered toMantrasco all the shares which they were holding in trust.

8. September 14, 1962 - BIR ordered an examination of Mantrascos books. This examination disclosed that:1.as of December 31, 1958 the 24,700shares

declared as dividends had been proportionately distributed to Manning,

McDonald & Simmons, representing a total book value or acquisition cost of

P7,973,6602.Manning, McDonald & Simmons failed to declare the said stock

dividends as part of their taxable income for the year 1958

9. Thus, BIR examiners concluded that the distribution of Reese's shares as stockdividends was in effect a distribution of the "asset or property of the

corporation as may be gleaned from the payment of cash for the redemption of

said stock and distributing the same as stock dividend."

10. April 14, 1965 - Commissioner of Internal Revenue issued notices ofassessment for deficiency income taxes to Manning, McDonald & Simmons for

the year 1958.

11. Manning, McDonald & Simmons opposed said assessments. BIR still held themliable for these assessments. Manning, McDonald & Simmons appealed to the

CTA.

12. CTA: absolved Manning, McDonald &Simmons from any liability on the groundthat their respective 1/3 interest in Mantrasco remained the same before and

after the declaration of stock dividends and only the number of shares held by

each of them changed.

ISSUES:

1. WON the shares are treasury shares2. WON Manning, McDonald & Simmons should pay for deficiency income taxes[

HELD/RATIO/RULING:

1. NOCONTENTION OF THE COMMISSIONER: The full value of the shares redeemed from Reese by MANTRASCO which were

subsequently distributed tp tje respondents as stock dividends in 1958 should be

taxed as income of the respondents for that year, the said distribution being in

effect a distribution in cash. The respondents interests were only .4% prior to the declaration of the stock

dividends in 1958, but rose to 33 1/3% each after the said declaration.

DEFENSE OF RESPONDENTS/CTAS RULING:

Stock dividends declared are not taxable because their respective 1/3 interestin Mantrasco remained the same before and after the declaration of stock

dividends and only the number of shares held by each of them changed.

COURTS RULING The assumption of both the parties that the shares, previously owned by Reese

which was subsequently paid for by the company after his death and there

after distributed as stock dividends to the respondents, were treasury shares.

However, upon careful study, the said shares were not treasury shares.

Treasury shares are stocks issued and fully paid for and re-acquired by thecorporation either by purchase, donation, forfeiture or other means. Treasury

shares are therefore issued shares, but being in the treasury they do not have

the status of outstanding shares.

Consequently, although a treasury share, not having been retired by thecorporation re-acquiring it, may be re-issued or sold again, such share, as long

as it is held by the corporation as a treasury share, participates neither in

dividends, because dividends cannot be declared by the corporation to itself,

nor in the meetings of the corporation as voting stock, for otherwise equal

distribution of voting powers among stockholders will be effectively lost and

the directors will be able to perpetuate their control of the corporation, though

it still represents a paid-for interest in the property of the corporation. In this case, such essential features of a treasury share are lacking in the former

shares of Reese: (see enumeration in p. 4 but in essence the court just pointed

out the next bullet) The manifest intention of the parties to the trust agreement was, in sum and

substance, to treat the 24,700 shares of Reese as absolutely outstanding shares

of Reese's estate until they were fully paid. Such being the true nature of the 24,700 shares, their declaration as treasury

stock dividend in 1958 was a complete nullity and plainly violative of public

policy.

- A stock dividend, being one payable in capital stock, cannot be declaredout of outstanding corporate stock, but only from retained earnings.

- Nature of a stock dividend: A stock dividend always involves a transfer ofsurplus (or profit) to capital stock. A stock dividend is a conversion of

surplus or undivided profits into capital stock, which is distributed tostockholders in lieu of a cash dividend.

2. YESThe ultimate purpose which the parties to the trust agreement aimed to realize

is to make Manning, McDonalds &Simmons the sole owners of Reeses interest

in Mantrasco by utilizing the periodic earnings of Mantrasco and its

subsidiaries to directly subsidize their purchase of said interests and by

making it appear that they have notreceived any income from those firms

when, in fact, by the formal declaration of non-existent stock dividends in the

treasury they secured to themselves the means to turn around as full owners of

Reeses shares.Manning, McDonald & Simmons, using the trust instrument as a convenient

technical device, bestowed unto themselves the full worth and value of Reese's

corporate holdings with the use of the very earnings of the companies.


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Such package device, obviously not designed to carry out the usual stock dividendpurpose of corporate expansion reinvestment but exclusively for expanding the

capital base of Manning ,McDonald & Simmons in Mantrasco, cannot be allowed to

deflect their responsibilities toward our income tax laws.All these amounts are subject to income tax as being a flow of cash benefits to

Manning, McDonald & Simmons.On the other hand, Commissioner should not have assessed the income tax on the

total acquisition cost of the alleged treasury stock dividends in 1 lump sum. The

record shows that the earnings of Mantrasco over a period of years were used to

gradually wipe out the holdings of Reese.Consequently, those earnings should be taxed for each of the corresponding yearswhen payments were made to Reeses estate on account of his 24,700 shares.

DISPOSITION: CTA judgment set aside. Caseremanded to the CTA for further

proceedings for the recomputation of the income tax liabilities ofManning, McDonald &

Simmons

VOTE: FIRST DIVISION; Makasiar, Esguerra, Munoz Palma, and Martin concur.

ADDITIONAL NOTES: Digest taken from the interwebz but edited some parts. I didnt

want to copy this digest I just couldnt find a copy of the original on line a nd Im so

tinatamad to retype everything so I just used this digest. So sorry!

-David

FISHER v. TRINIDAD

(October 30, 1922)

DOCTRINE: When a corporation or company issues "stock dividends" it shows that the

company's accumulated profits have been capitalized, instead of distributed to the

stockholders or retained as surplus available for distribution, in money or in kind , should

opportunity offer. The essential and controlling fact is that the stockholder has received

nothing out of the company's assets for his separate use and benefit; on the contrary,

every dollar of his original investment, together with whatever accretions and

accumulations resulting from employment of his money and that of the otherstockholders in the business of the company, still remains the property of the company,

and subject to business risks which may result in wiping out of the entire investment.The SC does not believe that the Legislature intended that a mere increase in the value of

the capital or assets of a corporation, firm, or individual, should be taxed as "income."

Such property can be reached under the ordinary from of taxation.

NATURE: Appeal

PONENTE: Johnson

FACTS:

1. That during the year 1919 the Philippine American Drug Company was acorporation that appellant was a stockholder of

2. Corporation, as result of the business for that year, declared a "stock dividend";that the proportionate share of said stock divided of the appellant was P24,800;

that the stock dividend for that amount was issued to the appellant;

3. Thereafter, in the month of March, 1920, the appellant, upon demand of theappellee, paid under protest, and voluntarily, unto the appellee the sum of P889.91as income tax on said stock dividend.

4. For the recovery of that sum (P889.91) the present action was instituted.ISSUES: Are the "stock dividends" in the present case "income" and taxable as such

under the provisions of section 25 of Act No. 2833?

HELD: NO. We do not believe that the Legislature intended that a mere increase in the

value of the capital or assets of a corporation, firm, or individual, should be taxed as

"income." Such property can be reached under the ordinary from of taxation.PETITIONERS CONTENTIONS:

- Cited US CASES which held that: "stock dividends" were capital and not an "income"and therefore not subject to the "income tax" lawCOLLECTORS CONTENTIONS:

- Admits the doctrine established in the case of Eisner vs. Macomber (252 U.S., 189)that a "stock dividend" is not "income" but argues that said Act No. 2833, in

imposing the tax on the stock dividend, does not violate the provisions of the Jones

Law

- Further argues that the statute of the United States providing for tax upon stockdividends is different from the statute of the Philippine Islands, and therefore the

decision of the Supreme Court of the United States should not be followed in

interpreting the statute in force here

- There are no constitutional limitations upon the power of the Philippine Legislaturesuch as exist in the United States

COURTS RULING: (Sorry medyo Doctrine vomit sya)

RE: Difference in US Statute and Act. No. 2833

- It will be noted from a reading of the provisions of the two laws above quoted thatthe writer of the law of the Philippine Islands must have had before him the statute

of the United States. No important argument can be based upon the slight different

in the wording of the two sections.

RE: Constitutional Limitations upon power to impose income taxes

- There is no question that the Philippine Legislature may provide for the payment ofan income tax, but it cannot, under the guise of an income tax, collect a tax on

property which is not an "income." The Philippine Legislature can not impose a tax

upon "property" under a law which provides for a tax upon "income" only.

- Constitutional limitations, that is to say, a statute expressly adopted for one purposecannot, without amendment, be applied to another purpose which is entirely

distinct and different. A statute providing for an income tax cannot be construed to

cover property which is not, in fact income. The Legislature cannot, by a statutory

declaration, change the real nature of a tax which it imposes.

- It is true that the statute in question provides for an income tax and contains afurther provision that "stock dividends" shall be considered income and are

therefore subject to income tax provided for in said law. If "stock dividends" are not

"income" then the law permits a tax upon something not within the purpose and

intent of the law.

RE: WON Stock dividends are considered income which may be subjected to income tax

STOCK DIVIDENDS DEFINED:

-

ILLUSTRATION: (Its easier to understand by way of this illustration)A and B forma corporation with an authorized capital of P10,000 for the purpose of opening and


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conducting a drug store, with assets of the value of P2,000, and each contributes

P1,000. Their entire assets are invested in drugs and put upon the shelves in their

place of business. They commence business without a cent in the treasury. Every

dollar contributed is invested. Shares of stock to the amount of P1,000 are issued to

each of the incorporators, which represent the actual investment and entire assets of

the corporation. Business for the first year is good. At the end of the first year an

inventory of the assets of the corporation is made, and it is then ascertained that the

assets or capital of the corporation on hand amount to P4,000, with no debts, and still

not a cent in the treasury. All of the receipts during the year have been reinvested in

the business. Every peso received for the sale of merchandise was immediately used in

the purchase of new stock new supplies. At the beginning of the year they were

P2,000, and at the end of the year they were P4,000, and neither of the stockholders

have received a centavo from the business during the year. At the close of the year,

instead of selling the extra merchandise on hand and thereby reducing the business to

its original capital, they agree among themselves to increase the capital they agree

among themselves to increase the capital issued and for that purpose issue additional

stock in the form of "stock dividends" or additional stock of P1,000 each, which

represents the actual increase of the shares of interest in the business. At the

beginning of the year each stockholder held one-half interest in the capital. At the close

of the year, and after the issue of the said stock dividends, they each still have one-half

interest in the business.- Generally speaking, stock dividends represent undistributed increase in the capital of

corporations or firms, joint stock companies, etc., etc., for a particular period. They are

used to show the increased interest or proportional shares in the capital of each

stockholder.

- In other words, the inventory of the property of the corporation, etc., for particularperiod shows an increase in its capital, so that the stock theretofore issued does not

show the real value of the stockholder's interest, and additional stock is issued

showing the increase in the actual capital, or property, or assets of the corporation,

etc.

- It is not denied, for the purpose of ordinary taxation, that the taxable property of thecorporation at the beginning of the year was P2,000 , that at the close of the year it

was P4,000, and that the tax rolls should be changed in accordance with the changed

conditions in the business. In other words, the ordinary tax should be increased by

P2,000.

INCOME DEFINED:- Mr. Black: "An income is the return in moneyfrom one's business, labor, or capital

invested; gains, profit or private revenue." "An income tax is a tax on the yearly profits

arising from property , professions, trades, and offices."

- Mr. Justice Hughes, in the case of Towne vs. Eisner, defined an "income" in an incometax law, unless it is otherwise specified, to mean cash or its equivalent. It does not

mean choses in action or unrealized increments in the value of the property

- "income" in its natural and obvious sense, as importing something distinct fromprincipal or capital and conveying the idea of gain or increase arising from corporate

activity

- Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speakingfor the court said: "An income may be defined as the gain derived from capital, from

labor, or from both combined, provided it be understood to include profit gained

through a sale or conversion of capital assets."

STOCK DIVIDEND NOT INCOME

- 'A stock dividend really takes nothing from the property of the corporation, andadds nothing to the interests of the shareholders. Its property is not diminished and

their interest are not increased. . . . The proportional interest of each shareholder

remains the same. . . .' In short, the corporation is no poorer and the stockholder is

no richer then they were before."

- The dividend normally is payable in money and when so paid, then only does thestockholder realize a profit or gain, which becomes his separate property, and thus

derive an income from the capital that he has invested. Until that, is done

the increased assets belong to the corporation and not to the individual stockholders.

- When a corporation or company issues "stock dividends" it shows that thecompany's accumulated profits have been capitalized, instead of distributed to the

stockholders or retained as surplus available for distribution, in money or in kind,

should opportunity offer.

- Far from being a realization of profits of the stockholder, it tends rather to postponesaid realization, in that the fund represented by the new stock has been transferred

from surplus to assets, and no longer is available for actual distribution.

- The essential and controlling fact is that the stockholder has received nothing out ofthe company's assets for his separate use and benefit; on the contrary, every dollar

of his original investment, together with whatever accretions and accumulations

resulting from employment of his money and that of the other stockholders in thebusiness of the company, still remains the property of the company, and subject to

business risks which may result in wiping out of the entire investment.

- We do not believe that the Legislature intended that a mere increase in thevalue of the capital or assets of a corporation, firm, or individual, should be

taxed as "income." Such property can be reached under the ordinary from of

taxation.

- WHEN IS STOCK DIVIDEND TAXABLE FOR INCOME TAX It may be argued that a stockholder might sell the stock dividend which he had

acquired. If he does, then he has received, in fact, an income and such income, like

any other profit which he realizes from the business, is an income and he may be

taxed thereon.

- CASH DIVIDEND v. STOCK DIVIDEND: There is a clear distinction between an extraordinary cash dividend, no matter

when earned, and stock dividends declared. The one is a disbursement to the stockholders of accumulated earning, and the

corporation at once parts irrevocably with all interest thereon. The other involvesno disbursement by the corporation. It parts with nothing to the stockholders.

The latter receives, not an actual dividend, but certificates of stock which

evidence in a new proportion his interest in the entire capital. When a cash becomes the absolute property of the stockholders and cannot be

reached by the creditors of the corporation in the absence of fraud. A stock

dividend however, still being the property of the corporation and not the

stockholder, it may be reached by an execution against the corporation, and sold

as a part of the property of the corporation. Until the dividend is declared and paid, the corporate profits still belong to the

corporation, not to the stockholders, and are liable for corporate indebtedness.

The rule is well established that cash dividend, whether large or small, are

regarded as "income" and all stock dividends, as capital or assets

- If the ownership of the property represented by a stock dividend is still in thecorporation and to in the holder of such stock, then it is difficult to understand how


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it can be regarded as income to the stockholder and not as a part of the capital or

assets of the corporation.

- A corporation may be solvent and prosperous today and issue stock dividends inrepresentation of its increased assets, and tomorrow be absolutely insolvent by reason

of changes in business conditions, and in such a case the stockholder would have

received nothing from his investment. In such a case, if the holder of the stock

dividend is required to pay an income tax on the same, the result would be that he has

paid a tax upon an income which he never received. Such a conclusion is absolutely

contradictory to the idea of an income. An income subject to taxation under the law

must be an actual income and not a promised or prospective income.

DISPOSITION: Having reached the conclusion, supported by the great weight of the

authority, that "stock dividends" are not "income," the same cannot be taxes under that

provision of Act No. 2833 which provides for a tax upon income. For all of the foregoing

reasons, we are of the opinion, and so decide, that the judgment of the lower court

should be revoked, and without any finding as to costs, it is so ordered.

VOTE: EN BANC; Araullo, C.J. Avancea, Villamor and Romualdez, JJ.,Street, concur.

Ostrand, Malcolm, Johns, dissent.

CONCURRING/DISSENTING OPINION: (There are concurring and dissenting opinions.

But, I wont be including them just because Maam usually doesnt ask for separate

opinions (other than the fact that I havent read it. )

-Kester (originally made by David)

4. Liquidating dividend

Wise and Co v. Meer

(June 30, 1947)

FACTS

- Plaintiffs are stockholders of the company, Manila Wine Merchants Ltd.(Hongkong Comp), a foreign corporation duly authorized to do business in the

Philippines.

- May 27, 1937 Board of Directors of MWM recommended that they adoptresolutions to enable the company to sell its business and assets to Manila WineMerchants, Inc (Manila Comp.) for the sum of P400,000.

- The sale was duly authorized by the stockholders of HK Comp and the contractof sale was executed between the two companies on the same date.

- HK Company made a distribution of its earnings for the year 1937 to itsstockholders (Dividends declared and paid on June 8, 1937)

- HK Company paid Philippine income tax on the entire earnings from which thesaid distributions were paid.

- After the June 8 distribution, HK Company had :o P74, 182 surplus resulting from the active conduct of businesso P270, 116 total increased surplus as a result of the sale of the

business and assets

-

August 19, 1937 special general meeting of the shareholders of the HKCompany, the stockholders directed that the company be voluntarily liquidated

and its capital distributed among the stockholders ; the liquidator, among

others, distributed the capital among the stockholders.

- Plaintiffs, as stockholders duly filed Philippine income tax returns.- The complaint was for recovery of certain amount paid by the plaintiffs

under written protest having been assessed of deficiency income taxes.

ISSUE

WON the amounts received by the plaintiffs on which the taxes in question were

assessed and collected were ORDINARY DIVIDENDS or LIQUIDATING

DIVIDENDS. They were LIQUIDATING DIVIDENDS

- When the deed of sale by authority of its stockholders, the HK Companythrough its authorized representative declared and agreed tat the aforesaid

sale and transfer shall take effect as of June 1, 1937 and distribution from its

assets to those same stockholders made after June 1, 1937 although before

before July 22, 1937, must have been considered by them as liquidating

dividends.

- [Holmby Corp v. Commr] . . . the fact that the distributions were calle