MODESTO.1. Flores, et al. vs. Case No, et al.

DECISION -

CASE NO. 134-9

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2 rach paid inheritance tax in the amount of ~247,- 062.41 based on said v~luation.

On August 7, 1960, Ha.ry 1. Bachrach died. The administrate~ of her estate filed an income tax return for Mary N. Bachrach ' for the period from January 1, 1960 to August 7, 1960 and another one for her estate for the remaining period of 1960. The bulk of the deceased's properties consisted of shares of stock of the Bachrach Motor ~o., Inc. (hereinafter referred to as old Bachrach Motor Go.). Thia company was a domes.t!ic corporation organ. .7P .. o. . May 28, 1910 for a t 1m of fifty (50 ) years, expiring on May 28, 1960. It imported, manufactured and dealt in cars, trucks and spare parts, and engaged in land transportation. It had an original authorized capital of ~ 150,ooo.oo, divided into 1,5uu shares with par value of it1 0.00 each (See Exhibit 11A,11 petitioner's exhibits, p. 2).

Out of this authorized capital stock, the following were subscribed and paid for as of the date of the incorporation: ln~~.tl2~1:SA ~Q.t" ~ N~h Q;( oha~~Hi MQll!lt Qf CLS ..

1. E.M. Bachrach 519 SYQ~~r1b~g & ~~lg it 1,900.00 2.

J. H. Sifert 1 100.00 ~: ""· 'l• Scott 1 1 uu. u H. B. Hacje 1 1UU.v0 5.

D.

1. li leming 1 100.00 \ The authorized capital stock was increased to 649,00o.oo, . 1,5oo,ooo.oo, and finally to ~ 5,uoo,oou.oo (See Exhibits 11C,.1 11D, 11 11E," petit:toner's exhibits, pp. 20, 25, 30).

The shares issued and outstanding 3~ ln .

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DECISION -

CASE NO. 1 34-9

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3 as of May 28, 1960 amounted to ¥1,993,4-0o.oc in the names of the following&

Names

1.

2.

~:

5.

6.

7.

.8.

9· Mary M. Bachrach Estate of Em 1 Bachra h

Neil Hankins

H. M. Levine

Elmer Madsen

Joseph Kaplin

.Pedro Cayetano

Leogardo Velilla

Modesto Flores

No. of Shar.es 13,236.3 6,683.7 2.(J 2.0 2.0 2.0 2.0 2.0 2.0 A.moun:!; '· ¥1,323,6)0.00 668,370.00 200.00 200.00 200.00 200.00 200.00 200.00 200 ,00 In the course of its operation, the old Bach- rach Motor Co. declared stock dividends. The stock dividends in December 1957 amounted to 6% of the earned surplus account or ~98,ooo.co; in May 1960, 15% or . it260,ooo.oo (See pp. 26Lt-265, t.s.n.; Ex- hibit 11EE, 11 p. 197, petitioner's e.xhi bits). Before the expiration of the franchisal life of the old Bachrach Motor Go., two corporations, the Bachrach Motor Co. (hereof referred to as new Bach- rach 1-lotor Co.) and the Bachrach Transportation Go., !nco, were organized to carry on its businesses. The assets and liabilities of the old Bachrach 1otor <.;o. pertain:tng to its business as importer, manufacturer and dealer in cars, trucks and spare parts were trans- ferred to the new Bachrach Motor <.;o., aod those per- taininr. to its land transportation business were transfez\red to the Bachrach 'l'ransportation Co., Inc. In consideration of these transfers of assets and liabilities, the stoc¥~olders o the old Bachrach Motor ~o. received shares of' stock in the two ne\JJ ..... orpora- tions in proportion to their stoc¥~oldings in the ; 388

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DECISION -

C SE i 0. 1349 _,., ol d corporation.

At the time of the transfer of a~sets and lio- bi lities . of the ol d Bachrach Motor Co., the estate of E .. Bachrach ovmed 33 .. 33% of the ca'Pital stock issued and outstanding of the corporation and the r est were in t he names of '·1ar y Bachr ach and nominal stochl1olders .

I t was ascertained that the shares of stock of the nor.1inal stockholder s were all endorsed in blank and were in the possession of the adminis- trat or of the esta t:e of ,1ary Bachrach. The book value of Mary's holdings at t he time of t he t r ansfer was ¥2,043,486.02.

'I'he followi ng tabulr. tion shows the stock.hol dings in t he old and new cor porations , to wit:

Name

No . of Shar es in ol d corp.

No . of Shares in the t\-JO new corporati ons ·rotal

Bl-1C

B'fC

---------------------------------~~---~~~----------- 1 " Mar y Bachra h 13,236.3 9, /'tl5. 6 5,040.4 3 , 250 .. 7 13,236.3 6' 683 0 '7

2. ,stat e of E. 1,643 .3

Bachrach

6,683 .7 ~ :

Neil Hankins

2 1 1 2 H. 11. Levine 2 1 1 2

5. Elmer l adsen 2 1 1 2

6. Modesto T. Flor es 2 1 '1 2

7. Joseph Y.aplin 2 1 1 2

8. L. L. Vel ill a 2 1 1 2

9. Pedro Cayetano _ £-- 1 1 19,9~ Tot al 19,93 A ver ificati on of t1e income tax return of the decease_d f or the period from Jannary 1 to August 7, 1960 showed· t hat the following proceeds received by Mary Bachi'ach were 'repor ted , not as part o her tax- 389

DECISION

CASE NO . 1349 5

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' able income, but as usufructt Bachrach Motors, Inc.

Consolidated Mines , Inc.

People's Bank & Trust Co .

Meralco

T o t a 1 ~ 1 0,250. 00 2,00 0 . 00 l.J- , 4.1.1-0 . 00 :!Is%~~:!

(See Exhibit 11W, " P• 155, petitioner's exhibits . ) These proceeds, respondent claims , are in excess of the usufructuary benefit s received by l'lary 1·1. Bachrach which, for transfer tax purposes, had been valued at 731,442. 19.

Accordingly , they are taxable as income of the bequest or usufruct. On February 12, 1963, respondent assessed the estate of Hary 1. Bachrach for deficiency income tax covering the period January 1 to August 7, 1960 and interest in the amount of ¥673 ,576.81, after credit- ing the claim for refund of the estate i n the sum of ~6,359.00 (See Exhibit ''6, 11 pp . 191, 193 , BIR rec.). There being allegedly no way of determining how much of the issued and outstanding shar es were cash subscriptions or capital paid in, respondent con- sidered the difference between the book value ( ft2 7043 ,436o02) of the shares in the old Bachrach Motor Co. at the t i me of t he exchange and the original authorized capital (¥150,ooo.co) of said corporation as liquidating stock dividends, 50% of vlhich are taxable\ as capital gains.

'l'he liquidating dividends pertaining to the 33.33% interest of Emil Bachrach were taken up by respondent as income of Mary M. Bach- rach.

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DECISION -

CASE NO. 1349 ,.

6 From t his assessment, Modesto f . ~lares , the co-adnlinistrator of the testate estate of Hary Ba ch- rach, appealed to this Court.

As cor!ectly stated by responaent, the issues involved in the instant case are: 1.

Did the exchange of shares of s tock result in a taxable gain to the t axpayer'( ..

2. If i n the a fflrma t :l ve , ~vhn t 1r1as the cost basis of the shares of stock in the old Bachrach Motor Co • ., Inc. •;

3. Is the sum of r-!107,848.26 r epr esenting the usufruct received from the estate of E. ti .. Bachre1ch taxable as income?

The controversy hinges on vJh{::ther !'lary H ~ Bach- rach realized taxable income as stochl1older of the old Bachrach Hotor Company upon acquisition of the shares of stock of the new Bachrach Motor Co. and Bachrach Transportation Co. , t hrough exchange of share for share vJith the old Bachrach Hotor Gompan~r · It is petitioner's theory that there was no such corporate liquidation as to give rise to taxable li- quidating dividends.

He argues t hat, although what tbok place between the old corporation ar~ the two ne\i corporations was not ordinary merger or consoli·· \ dation, nevertheless, it was well within the sta- tutor y "ac4uisition by one corporation of all or substantially all the properties of another corpora- '.

DECISIOll -

CASE

JO. '1 34-9 •' ' tion solely for stoc -:. 11 7 Consequently, it is urged that the gain resulting from the acquisition or ex- chance of stocks should not be recogniz .d under Sec- '· tion 35(2) of our Hevenue Code , as amended by Hepublic Act No. 1921.:.

We agree with respondent., vlhen the corporate term of the old Bachrach Fetor Ccrn r ,:< r~ y <-:X,L):.i. l'ed on May 28 , 1960, this corporation automatically dls- solved., 11x x x That the corporate existence ~ !a~ ceases upon the eXpiration of the period for v1hich it wns created is as a gen- eral rule, and apart from t he op ~ ration of a modifying statute , undoubted; when that date is r ea ched , the corpor~tion is ~ ~~ di s- solved , without any direct action on t he part of the state or t he members of t he corporatlono x x 11 (13 Am. Jur. par., 1286, p. 11 58.) 11I f the la\·T under \vhich a corporation is organized, or t he special act creating tho corpora- tion , fixes a definite time \·then its corporate life mllSt end, it is evident that vJhen that date is r eached said corporation is ~ facto dissolved , without any direct action on the part of the state or its members."

(4'1 .&1 , p .. 1298.)

The transfer of the assets and liabillties of the old Bachrach gator Go . t o the ne'.·T Lachrach Botor Coo and Bachrach Transportation Gou , Inc . was in effecJ a corporate liquidation . Jhil e t he a sset s were never converted into cash f or dist.r:I.bution to the stockholders or for the set tlement of corporate obligations, there was, however, a l iquidation as J9.2 •

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DECISION -

CASE NO. 13lr9

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8 the stockholders received the equivalent value of their holdings when shares of stoc1c of tbe two new corporations were received in exchange of the transferred assets and liabilities in proportion to their stockholdings in the old corporation. 'rhus - 11 fnere a corporation surrendered its charter, dissolved, and trans- ferred all of its assets, including ·its surplus, to a partnership com- posed of the shareholders in the corporation, who retained the same proportionate interests , under an agreement entered into beforehand to carry on the business as it had be- fore been carried on by the corpora- tion, the transaction was in effect a transfer to each shareholder of the value of his shares of stock, and re- sulted in taxable income a s to the surplus so t;;:ansferred.

Huffm,an 1 s Appeal L1924/ 1 B. T. a. LFed./ 52.il {65 ALR, p. 150.)

'rhere being a dissolution and l j.quidation of the old corporation, the gain realized by the stock- holders in the dissolution and l iquidation is sub- ject to income tax pursuant to Section 83(a) of the ' Revenue Code, the pertinent provisions of which read:

"Sec. 83.

Qj.~t .r_ibntioo of divj,.- 9-Jmq~ 2r assets by gq,rno.ra. t;i..on.s. .. -

X

X

X

X

X

"Where a corporation d:tstri- butes. all of its assets in coro- pl~te liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether indivi- dual or corporate, is a taxable in- come or a deductible loss, as the case may be. 11

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DECISIO

CASE

JO . 131t9 9

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The petitioner co.nnot claim non-t>ecognition of the gain realized by Mary M. Bachrach. Section 35(2) of t he Revenue Code , upon which · his claim is based, provides : ' 1(c) Exchan~e of property-

X

X

X

X

X

11 (2) F(~ceptions. - No gain or l oss shall be recognized if in pur- . suance of a plan of merger or con- solidation (a ) a corporation vJLich is a party t o a merger or consolidation, exchanges property solely for ~tock in a corpor8 tion whi h i s a party to the merger or consolidation , (b) a shareholder exchanges stock in a corporation which is a party to the merger or consolidation sole- ly for the stock of another corpor- ation, also a party to the merger or consolidation , or (c) a security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such cor- poration solely for stock or securi- ties in another corporation, a party to the merger or consolidation.'' The gener· 1 rule is that upon the sale or ex- change of property, the gain realized therein is subject to income tax and the loss is allowed as deduction for income tax purposes. The law , however , admits of exceptions, that is , no gain or loss shall be recognized if in pursuance of a plan of merger or consolidation , (a ) a corporation , which is a party to the merger or consolidation exchanges property \ solely for stock in a corporo.tion, also a party thereto; (b) a shareholder exchanges s t ock in a cor- 394

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DECISIOl' -

CASE UO. 1349 , .

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poration which is a party thereto solely for stock of another corporation, likewise a party thereto ; and (c) a security holder of a corpor 8 tion which is ' a party thereto exchanges his sec~~ities i n such corporation solely for stock or securities in another corporation, also a party thereto $ 'fue Code defines ''merger" and "consolidation, 11 thus - 11Sec. 35.

x

X

X

X

11 (5) ~finitlous.-(a) x x "(b) 1'he term ' merger' or ' con- solidation,• when used in this sec- tion, shall be understood to mean:

(1) the ordinary merger or consolida- tion, or (2) the acquisition by one corporation of all or substant ially all the properties of another cor- poration solely for stock:

t r Qvideg, That for a transaction to be regar d- ed as a merger or consolidation within the purviev; of this section, it must be undertaken for a ~ flde business purpose and not solely for the purpose of escaping the burden of taxation:

f.r:oyig~g, f urther, The t in determining vJhether a ~ ~ business purpose exists , each and every step of the transaction shall be considered and the v1hole transaction or series of transactions shall be treatGd as a single unit: Proyideg, finall,x:, 'l'hat in deter- mining whether the property t rans- ferred con3titutes a substantial por- tion of the property of the transferor, the term 'property' shall be taken to include the cash assets of the trans- f.eror 11 In a mer ger, two or more corporations unite by the transfer of property of ull to one of them, wl ich 395 ..

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DECISIO

CAS""' NO . 1349 1 1 continues to exi st 01etror>ol1 tan ... dison Co. vs. Com- missioner of Internal Bevenue , 98 F. 2d 807) . consolidation occurs 1:1here tv10 or more exis ting cor por tions are united into a single corporation and the existence of the uniting corporation is ter- minated and the organizat:l.on succeeds in a general v1ay to the f ranchise of and acqui re s the pr operty and assets and assumes the obligations of the constituent companies Olords & Phrases , Vol . 8-A, Pf'• 346- 34-7, quot:tng Collinsville Nat. Bank v . Esau , 1'76 P. 51'+, 515, 74 Okl. 45) .

Both mer ger and consolidation are promotive of corporate unions or combines. It is precisely for the promotion of corporate combinations, which bring about the pooling of r esources , that v Congress , in Republic Act No . 19 21, decreed a differ- ent trea t ment in gains and losses resulting from ex- changes of properties , As explained by the authors of H. B. No. 6485::

111rhis method of Philippine Income t ax in dealing with the problem of re- cognition of gai n or loss from exchange of property in connection with corporate combinations i s a deterrent factor to the economic development of the country. It discourages corporations from pooling t heir resources , thereby blocking one of the most i mportant means thru \-Jhich large concentrations of Phili ppine in- dustries can be obtained.

In other wofds , the present tax treatment of exehange of propert y under our laws is a disincentive to busines s to com- bine and expand.

Actually its net effect is to place corporations in what may be termed ' a tax straight 396

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DECISION -

CASE Nv . 131,.9 12 j a cket 1 f rom -v;hich tney could t:scape only at prohibit ive cost~'~ (hxplana- tory Note of H. B. Nc . 64-8). ) As afore- stated , the old Bachroch Motor Go~ transferred al l i ts assets and liabilities to two nevt corpora ti.ons , the new r)e chrach t ·~ot or Co. and the Bachrach Transportation ~o . , I nc.

the stock- holders surrendered their sto c~ s in the t ransferor- company and received stocks i n the transferee- corpor ation~ ~ The r eorganization was a divisive type, a split-up .

It was , therefore , nej_ther a mer ger nor a consolidation.

Cbviously , this re- organization cannot quali.fy as o t ax·-free reort;an:l..- za tion under Sec . 35(2) of the Hevenue Code . Hence, the gains realized by riary r·: . Ba chrach in the ex- change are taxable i ncome .

In the computation of t he taxable gain realized by r~ ary Ivl. Bachrach, respondent Conuni ssioner adopt ed the bodk value (¥2 , 04-3 ,436.02) of the shares in t he old Bachrach Motor co.

This value i s not disputed by petitioner .

Consequently , we shall so consider it in computing the taxable gain. Similarly , in arriving a t the taxable gain, he considered t he original authorized cap:i.tal of t.h. f~ old corporation 0 "150 , 0UU. OO ) as the cost basis of the shar es of stock.

He de-

ducted ~rom the book value of ~2 , 043 , 436 . U2 the ori- ginal authorized capital of !C15l·, CUL· . cc , ther eby dis- regarding the subsequent increa ses in the capital- ..

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DECISI .. - CASE r1CJ .

13Y·~

•' ' 13 ization.

The certifi cates o · incre ses of the eapital st ock of t e old corpcrction ~Exhibits 11D, 11 and 11E11 ), including the t reasurer's cer- tificates, establish the fact tillit said increases in the respective sums of t.30Lr,COO . cu, "-290 , oo . on and 175,00 .oo 1.vere paid in cash., These inc.reas s, totalling ~769,000 .. 00, should be added to the original authorized capit al of ¥-15CJ,COCJ.,CJu (which, in t he absence of evidence to the contrary, ~e consider ~s fully paid Vp) because they f orm purt of the p"id- in capital.

Cons~ quently , the increases of ~769 , - 000 . CO and t e author ized capital of f 150,UU).OO, vhich total 919 1000 . 00, represent 1.mder the circums- tances the cost basis of the shares of the old Bach- rach Hotor Co .. r-lfld should be deducted from the book. value.

In fine, the resulting difference of :t<1, 1 :..o.4,- 436.,02 is the t axabl e ga.in realized in the liquida- tion.

Finally , petitioner questions the income t ax assessment in the amount of i'10'1 ,848 .. 26 , vJhich re~ ­ pondent considers as the excess over the valuation (¥?31 ,442 .. ·19) of' t he usufruct recetved from Nar y N. Bachrach's r us band.

:rre contends for the non- taxa·~ bility as income of t his excess on the ground that 1 t is 'a part of the .Q.Qfl?J~ of the estate of the husband o ftespondent, owever, sl·:ggests that +his 398 •/

DECISIOrl -

CASE NO . 1 3l+9 , .

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excess constitutes an income of the bequeathed usu- fruct, and, therefore, is taxable under Sec. 29(b)

(3) of the Revenue Code. The sum of ¥100,250 .. 00 , representing stock divi- dends corresponding to the shares of the estate of E. N. Bachrach in the old Bachrach Hot or ~o., is taxable as income in consequence of our resolution of the fir s t issue.

·J/i th respect to t he bala.nce of t-7 ,598. 26 , it may be sta ted that petitioner admits said balance to be proceeds (of the usufruct) from the Consolidated Mines, Inc., eople's Bank & Trust Co. and 11eral.co.

Being proceeds of the usufruct they· are taxable as income under 'ec. 2S: (b)(3) of the Revenue Code.

But petitioner argues that the proceeds have already been taxed when the :i.nheri tance tax on the bequest was paid.

'l'he inheritance tax was assessed on the value of the right of usufruct (see Sec . 91 of the Hevenue God e).

wna t is novJ being taxed is income in pursuance of Sec. 29(b) (3) of the same Code.

WHEl{EFORE , the assessment appealed from 1.s her eby modified and petit ioner Nodesto Te Plores, as co- admi nistrator of the testate estate of the late I··ary

14. Bactirach, is ordered to pay to the C<?.mmissioner of Internal· Revenue or his rE:presentative the sum of "316,541.00, with i% onthly i nterest from April 18, 1961 to I•'ebruary 12, 1963. If the deficiency 39 •.

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DECISI0IJ -

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u. 1 34-Sl 1 5 tax is not pdid within thirty (30) days from the date this decision becomes final, petitioner is ordered to pa.y surc11arge and interest CIS ll.rovided in Section 51 (e) of the .kevenue Code .. · '.li tll mt costs,. ezon vity, December 29, 1964.

I CONCUR:

-- ~~---~ ..___ ROMAN l-1. . !'·Ul.LI . - .

Associate Judge

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