U06l1c 0 P Fill\! P~UU~Pi ""\ Court of Tax Ap'Pea Quuon Cl'R.F P.I. Manufact'Ring, Inc., et al. vs. The Commissioner of Internal Revenue, et al.

DECISION -

- 2 - •

Section 25(a) of the National Internal Revenue

Code imposes an additional tax upon ... a corporution formed or availed of for the purpose of p reven ~ing the imposition of the ta~ upon its shareholder s Ol he shareholde r s of any other corporation thro1gh the medium of permitting its gains and profits to accumulate instead of being divided or distributed. And Section 25(c) provides th~t the fact that earninga or profits of a corporation a~e permitted to accumulate beyond the re~sonable needs of the business shall be dete rminative of the purpose to avoid the tax on share- holders unless the corporation shall prove to the con- trary by_a clear preponderance of the evidence. Petitioner is a corporati '~ !i July organized and existing under Philippine law, with principal office and place of business at No. 97, Industrial Avenue, Northern Hillb, Malabon, Metro Manila. It is engaged in the manufacture and sale of electrical appliances and plumbing supplies.

· Or1.0ctober 14, 1965, petitioner whose accounting period is the fiscal year, filed its income tax return for the fiscal year ended June 30, 1965. After veri- fication of the return and investigation of petitioner 1 s books of accounts and other accounting recorJs, res· pendent Commissioner of Internal Revenue, upon

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- 3 - •recommendation of the investigating revenue exa1iner, assessed and demanded from petitioner the amount of P883,191 .06 representing surtax of 25% and ~% ~ntere st on the latter's unreasonable accumulated surplus i the amount of ~2 ,993 ,867 . 25, computed as follows:

y 1964-:..965 Unreasonably accumulated surplus 25% surtax due thereon

Add:

~% monthly inte r es. from .!l2,993,86_7.2~ .!?1 748,467.00 l .)-16-65 to 10-16-6 8 • • ._134, 724 . ...Qii Total amount due and collectible • ·l==~~~£1~l~2~ The assessment and demand were contained in a letter of respondent dated October 12, 1970. In a letter dated Dscember 11 , 1970, petitioner protested the assessment .

However, on Janua ry 15, 1973, re pendent denied petitioner's pL c test and reiterated the d8mand for payment of the assessment . gence, ·the petition f or review.

The sole issue fo r _decision is whether petitioner P.I. Manufacturing, Inc. was availed of in the fiscal year ended June 30, 1965 f or the purpose of avoiding the ·impos ition of the income tax on its shareholders by permitt i ng its earnings a.d profits to accumulate instead of dividing and distributing them. The pertinent provisions of Section 25 of the National I 1ternal Revenue Code, the l ~w under which respondent'commissioner of I 1ternal Rev enue assessed 220

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- 4 - ~the corr e~ponding 25% surtax for unreasonable accumulation of surplus f or the fiso~l year 1064- 1965, read at the time as follows: SEC. 25.

Additional ta ;i_-D.__~orpo :a tion impLQL~rly ac_c~mulat.in g profits or surplus .- (a) Impos ition of tax.- If any corporation, except banks, insurance co~p ~ri es, or per- son - 1 holding companies, whether domestic or foreign, is formed or availed cf for the purpose of preventing the imposition of the tax upon its shareh ld~rs or msJbers or the shareholde rs or membera ~z anothe r corpo- ration, t hrough the medium tif permitting its g ins and prof its to accum late instead of being divided or distributed, there is levied and assessed against such corp ration, for each taxable year, a tax equal to twenty- f ive 12er ~!ltum of t!.e undistrituted portion of its accumulated profits or sur~lus whicl shall be in addition to the tax i:mposeJ by section twenty-four, and shall be computed, collected and paid i n the same manner and subject to the same provisio~s of law, in- cluding penalties , as that tax.

XXX

XXX

(c) . Ev idence det ermin 2.t~i.Y..~.L.Euq~ se .- The fact that the earnings or profits of a corporation are permitted to accum1late · beyond the reasor.~ble 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.

Since the provisions of Section 25 of the NaLional Internal Revenue Code were bodily l ' fted from Section 102 of the u.s. Internal Revenue Code of 1939, including the regulations issued in connection therewith, it would be proper to refer to applicable cases decided by the

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- 5 - '"Americ an Federal Courts for guida.:c e and enlighten- ment.

(Manila vhne Merchan ts I I nc . vs. CommisG ioner of Internal Revenue , No. L-26 145, Feb. 20, 1984, 127 SCRA 4? 3.)

A prerequisite to the impositi n of the tax h2s been that the corporation be formed or availed of for the Eu r pose of avoiding the income tax {or surt ~x ) on its chareholde r 1 or on ~h~ snareholders of any other corporation by permitting the earn~ngs and pro- fits of the corporation to accumulate inste2d of dividing them among or distributing them.to the share- holder s.

If the failure to p a y dividends i~ du0 t o some other cause, such as the use of the undistributed earning s a nd profits for the reasonable ne de of the business, such purpose does not fall within the in te r- diction o f the statute.

(Mer~ cns , Law o f Federal Income Taxation, 701 . 7, Chapt.:. .. r 3 9 1 p. 44; See also Sec . 21, Rev. Regs . No. 2; Manila Wine Merchants, Inc . vs. Commissioner o f Internal Revenue, §.!:!J2~·J . · Inasmucn as purpose involves a state of mi nd or intent, it ls always necessary t o look at t be sur- round i ng circumstances ar.d the attendant facts in each individual case to determine whether the purpose of the failure to make ~ i ~tribution was to permit t:e s haLeholders to avoid the income tax or f or -orne othe r

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DECISIOlJ -

- 6 - ~purpose, such as the use of the earnings ~nd profits for the reasohable needs of the business. In th~s regard, although the testimony of the taxpayer, officers and stockholders is entitled to some weight, generally the issue is to be resolved in the light of the surrounding circumstances, including the in- t rests of lhose in control and their actual conduct. (Mertens, Law of Federal .inc._,me'Ta:x:ation, Vol. 7, Chapter 39, p. 45.)

The applicable principles of law are clear and in the end the decision in this case must rest upon its own peculiar facts and cir- curnstances.

The circumstances relied upon by respondent as ind i cating that retitioner has permitted its earnings to accumulate beyond the reasonable needs of the busi- ness are as follows:

{Examiner's memo ... andum, Exh. "3 11 , pp. 56-58, B!R records;

See also Exh. "1", pp. 28-29 & Exh. "B", pp. b9-90, BIR records.) a.

The payment of management fees to its sister company;

b.

The fact that the company has not declareJ dividends in the past;

c.

The retention of treasury stock;

d.

The fact that at the time ~f examination the company s financial con- dition warrants the declaration of divid~nds. The findings of respondent's examiner with regard 22,}

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PECI SION -

- 7 - ~t o ~he manage 1ent fees paid by petitioner to the Go Soc & Sons and Sy Gui Huat, Inc.~ as stated in his memorandum reports, are as follcws: "Verification shows tha t the P.r. Manufacturing, Inc., is a sister corpo- ration of the Go Soc & S ns & Sui Gue Huat, Manila nd Phi l ippine Paints, Inc., al so of Malabon, Rizal.

The se three corporations are family corporations, in the s ens2 t hat the s tockholders of these three corporatio ~ s are the same. The President of P. I. :'1-a:.ufactur ing ~ Mrs. Cor r elia Co is also one time pres i. Je:1t of Go Soc & Sons & Sui Gue Huat.

The same is true with respect to Mr. Jose P. Sy.

Members of the board of directors of Go Soc are likewise members of t he board of directors of P.I.

Furthermor e, the stockholders cf t he three corporation are related if not by consanguinity by affinity."

(Exh. "A", also Exh. "1", p. 29, BIR records.)

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"This facts (sic) created an awkward situation which c~nvinced the undersig .ed to assert that the taxpaye r h ~ rein has placed itself in an untenable position • . This becomes a case wherein the decisions and actuations of the officers and/or board of directors of the P.I. Manufact- uring, Inc. is subject to managem2nt and review by another company whose officers and/or board of directors are the same officers being manc..,;;Jed.

11 (Exh. "3", p. 57, BIR records. )

"x x x i t may be claimed in this regard that the payment of the management fee by the company to a sister company constitutes a way of or a device to deplete its surplus i~ ~ ome for the pur- pose of evading the imposition of the surtax under Section 25(c) of the National Internal Revenue Code as a~ended . 11 (Exh.

"B", p. 89, BIR records.)

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- 8 - ~ There is merit in respondent's contention. Al t hough the deductibility of the management fees a s an operating expense is no longer in issue in thi s case, nevertheless , it bears close scrutiny, sinc e t h~ payment of man agement fe~s by petitioner t o a company whos~ controll ing stockholders are one and the same as peti ion r 's is material to the issue on hand.

As correctly noted by respondent's examiner, .

the records show that the management c~ntract between pe t itioner P.I. Manufacturing, Inc. and th0 Go Soc & Son s a nd Sy Gui Huat, Inc. was signed on D8cembar 20, 1963 by Sy Ching as execu t ive v i ce president of the P. I. Manufact'Jrit:g, Inc. and by Cornelia L. Co as president cf the Go Soc & Sons and Sy Gui Luat, Inc . (p . 1 7, BIR records . )

The income tax returns o: the P.I . Manufacturing, Inc. for the fiscal year ended J une 30, 1965 was signed by C2rn~lia L . Co as its pl..esiden t also.

(p. 21, BI R records . } When said exami ner testifie durirg the hearing of tte case , ~1e reiterated the same findings contained in h i s memorandum reports and insisted on tl:e c onnection of the payment of manag ement fees to the issue of un- r ea ~ anable accumulation .of sutrlus. Upon cross exam- ination, counsel for petitioner failed to discredit 22cJ t

- 9 - •the testimony of the ab~ve witness for respondent, neither did the former present any rebutt 1 evidence to controvert the latter's assertions. (t.s.n~, pp.

8-18, pp. 40-45, August 6, 1982.)

It a.pears, therefore, f~om the uncv~Lradicted findings of re~)ondent's examiner that pet~tioner and .

the Go Soc & Sons and Sy Gui H•n'~., In"'. have the same stockholdersf the same bor.t.LJ v£ directors and are closely held corporations.

Corporations most vulne- rable to th~ accumulated ea~nings tax ha a been cor- porations the stock of which was owned or controlled by a single fa:uily or at the most by a fe-vJ indiv.,_cuals. {Mertens , Law of Federal Income Ta~ation, Vol. 7, Chapter 39, p. 111.)

Thus, the management fees paid by petitioner to its sister company have to be care fully examined.

By the terms of the management contract, the compensation o r man~gement fee to be paid by pcti- i:.ioner to the manager"for the services to be rendered by the latter to the former shall be the equivale~t in pesos, Ph1llppine Currency, of t ree per csnt (3%) of the first one million pesos (Pl,OOO,OOO.CJ) .of net sales for each fiscal year; and five per cent (5%) of such s ~les in excess o. f OnP ml'lll'on nesos (Dl ono 000 00)" - ..

:.!:', u , • •.

(Management Contract, p. 18, BIR r ecords.) 22ti

DECISION -

CTA CASE N0.2500 - 10 - ..

The following is an analysis of petitioner's rna agem~nt fees paid, total adm ini st~ative and general expenses which include management fees, percent2ge of management fees to general and administrative expenses and net income before income taxes for the fiscal yc~rs ending June 30, 1958 through June 30, 1 65, as reflected in the financia l statements subm1tted by petitioner: .~ drr· ; '1 is t rat i v e

Percentage

Net

c. General Ex-·

of Management Income

Fiscal

penses including fee to Adm.

J::.efo~e Exh.

Year

Management

Han·agernc.. n t Fees and Gener al

Income

No.

Ended

Fees

E~·-penses 'I'<::x

E-2

June 30, 1958 :Ell47,884.32 J:i281,401.35 52.55% ~818,757.56

E-2

June 30, 1959 180,129.43 380,632.31 47.32% 1,138,49:.01

F-2

June 30, 1960 199,262 o7 2 482,306.38 4!.:.<:1% 1,447,117 . 32

F-2

J t:ne 30, 1961 183,035. 48 568,150.49 3:..:..2 1% 615,488.87 G-2;

G-4

June 30, 1962 262,899.00 1,058,442 .32 24.83% 1,097,544.33 G-2;

G-4

June 30, 1963 264,884.70 l.,J..67, 045.11 22 . 69% 638!228.86 H-2;

H-4

June ·30, 1964 267 967 .30 652,725.65 41.05% 588,416.98 H 2;

H-4

June 30, 1965 311.,804.08 648,709 . 51 48.06% 1,087,985.74 The above 2nalysis shows that the management fees paid fer the fisc al year ending June 30, 1965 in the amounL of ~311,804.08 was 48.06% of the t~ta1 adminis- trative and general expenses amounting to P64&,709.51 for that ·ear .

Had this management fee not been ex- pended, :t would have formed part of net income which would later on be credited to ret ined earnings. The same holds true f r the n~<. .. ;;agement fees paid in i.:.h" previous ye..ir s.

if these fees had not bee-~ paid they

DECISION -

CTA C AS ~ NO. 2500 - 11 - ~ould hav been subs antial addi t ions to re t a i ned earnings, since the financial s t atements r eveal th a t t he manage men t fee was the l argest e xpense i n ~ ~red every year alt.ong the admi nistr a tive and g e ne ral ex- penses, e xc e pt f or the fiscal years_ending J une 30, 196 2 nd 1963 when i t wa s second on ly t o t axe s and licenses.

(See Exh;;.

11 E-2", "F- 2", "G- 4", "H~ 4 " a nd "I-4", pe titioner's enve lop..:.:. ) Consid e r i ng that pe titioner d id not prove the re ason a blene s s of its paymen t of such management fees to a company whose controlling stockholde r s are the same as peti t ioner ' s, we fi nd re spondent's stand u n thi ~ matter well taken .

Apparently, t he clos relation- shi p bet ve e ~ petit ion .r and the Go Soc & Sons and Sy Gui Huat, Inc., bec a u s e of c omplete owne rship a nd con t rol by the same stockholde rs a d the sa r ~ board of d i rec ors, was used in e f f ect for t he p u r pos of avoid i ng the su r t ax.

With reg ard t o the dividend distribut i o n , petitioner clai s tha t con t r ary to r e sponde nt's alleg ation , it had be en paying s ubs tantial d i vide nds prior to 196 4 ~ nd 19G5 in amounts it c ou l d affor d subjec t to its wo rking capital needs u!1d i t s ex an 3 ion progr a m. To t r ace the h istory of dividend dis tr ibutions made by petitioner a s di 2clos e d by its f i nanci a l sta t e ments, summar ized in Annex "A" are petitioner's net income a fte r 22ci

- 12 - ~ta xes, a justrnents to earned surplus , dividend s declar e d and e ar ned surplus ba l ances ~ for the fiscal years e nding JJne 30, 1956 to June 30, 1 96 5 . .

No te tha t for the years 1958, 196 0 , 1964 nd 1965 ther e were no dividends declar ed although pet i - t ioner r eal ized s ubstantial p~ofits and had s uf fic ient earned s urplus· balance s in those years. For t~e tax- able ye a rs 1956, 19 57 , 1959 l 0 6 l , 19 62 and 19 63 the ye a rs when dividends were dec l ared, al l dividend dis- tribu t ions made were in stock , except for 1959 and 1961, whe n 42 . 48% and 50 % r e spec tively of the total d ividends d i str ibuted we re in cash and t he balances in stee L. While i t i s tr e t hat petit i oner declared dividends in the years ment i oned, its stockhol ders were subj ect to tax only on the c ash dividend s they received for the years 1959 a nd 1961.

Stock dividends even t hcugh t a x exempt neve r theless capital i ze earn ing s a nd result in a reduction of profits avai lable for distribution wher e the purpose a t the time . of i ssuance of the ctock dividend is tax avoidlnce. In the ligh t o f r espondent ' s other findings, suc h a div i dend policy as petitioner's invites jud icial sus- p icion that the proscribed purpose most l ikely exists. The principa l reason advance d by pe t itioner for its failure t o pay dividends f o r t he year s ending 1 964 22d /

DECISION -

CTA CASE NO. 250 0 - 13 - »and 1 965 was the fact t hat t he company \•la s c o·1strained t o acquire treasury stock of 11 ,116 . 46 sh::;···2s i n 1 964 , wh i ch was increased by a minor amount in 1 9ci 5 to 11 , 121 .6 shares 3 at a t otal c os t of P2, 043, 417.2 2; and a s a result of t his acquisition of t re asury stock , petitioner's d ividends i n 1°65 wer e restr ict .d to the equ i valen t of t heir acquisiti n c os t f or a3 long as the s hares \ve re held in t rc .: stL y , pursuant to 'the requirement by the Securities and E ~change Commission as l aid down in its ru l ings .

(Petitioner' s Ilemorandum ,

p. 204, CTA re co ~{s ~ ~P· 218 - 220, CTA recor ds .)

On the o the hand , re P?ondent po i nts out t hd t t his acquisition a nd retention of treasu r y stock • t-1 l.S an o~...ne r circ umstance that indica tes that peti tioner unreason · bly accumulated its surplus.

We agree wit h r espondent's i ew.

Treasur y Stock is customar "ly define d as s tock of a corpora t ion t hat has been legally issued as fully paid and t hereafter has been r eacquired by t he corpo- ration throug t purchase , donat ion or settlement of an obliga t ion a~d has not been f ormally c ancelled. I n the ins tant case, ·etitioner reacq~i red its s t ock by purch cse in 1J64 a nd held this in treasury in 1965 t hrough 1966 .

A~ indicated in i ts balance sheet f or 19 G5 (Exh . "H- 1 " ) '· t he redemption c o ~:; t of 230

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DECISION ·-

CTA C SE NO. 2500 - 14 - ~1 , 116.6 shares in 196 4 was P2,042,522.22 which was increased to P2,0 43,447 . 22 · n 196 5 with the addition of 5 shares, br "nging t he total number of shar es t o ll,l2l. J .

The ·earne d surplus ba l a nceu t th8 end of the fisc a l yea r s 1964 and 1965 were ~ 2 , 224,277.51 and P2, 99 3,867. 25, r es ec t ively.

(See Annex "A

11 .)

The .

balance sheet for the year en d~n g J ne 30, 1967, with comparative f i gures for 1 9 6 '~ (.::d1 . "I-1") '· shows under "Stockholuers E-:1ui ty" that these tr e asury shares re mained in the tre a sury through 1966 and were sold in 1967. On the asset side of the same balance sheet are reflected two receivable accou nts from stockholde rs in 19~ 7 as follows:

Due from stockholders - curr e nt portion (Note 2) •••••.• . •••• •• . ~ 458,437.37 Due from a stockholder - net of por t i on shoqn unde r c urrent ass e ts

(Note 2)

• ••••••••• Pl, 4 07 , 840 . 0~ T o t a 1 The explanat iG n for these accounts reads : (Exh . "I - 5") "N te 2.

Due from Stockhol de rs Th is r e pre s e n ts t he unpaid balances on t he c ompany's t reasury stock sold to stockhol ~e rs together with the interest accrued the r e on .

A s toc kholde r who pur- chased 1 0 ,871.3 2 sh a res of the treasury st o c~ at an original amount of P2,011,194.20 will pay t h~ company in s ixty equ l monthl y i nstal :;nen t:s of P33,5 20 .00 until December 2, 19 71 at c::tn i.n t0 res t rate of 8% per annum." Thus as of June 30, 1967, t he total outstanding amo1nt due fr om stock holders on acc ount of their purchas e 23.1 /

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DECISIO L'l -

CTA CASE NO. 25 00 - 15 - ~f t he treasur y s har es was ~ 1,866,277. 3 1 o f wh:ch ~1 1 407,840.00 was due f rom one s t ockhol der p a abl e in equal monthly ins ta.llments up to December 2, .1971 as e xp l ained above .

The mere fact of reder,ption of .stock f urni sLes no basis for i rnpcs ition of t he surtax . Whe n, however , the redempt 'on is do. e out of cash accumulatiomwhich r e a sonably may be thought ex ;e~s 1 ve , s uch a p urc ha~ e , along with o the r f actors a y a ppropriately be consi- dered in ar riving at t he ul t iroate findin g . (Me rtens , Law of Federal I1 c ome Taxat ion , Vol. 7, Chapter 39,

p. 7 . } The t o ~c h s~one o f l i a b ility is the purp0se behind the accui .. ulc:<tion of t he income and not the con- s ~ q ue n ce o f the accLmulat ion . Thus, if tha fai lure to ,pa y d i vidends is due to some o t her c ause such as t he us e of undistribu ted earnings and profi ts for the r eas onab le needs c~ the business , s uch pur pose does not f a ll w' th in t he interd iction of the s t a tute.

(Manila

Wine Mercl 1 an~s , Inc. vs. Commissioner of I nterna l Re venue, s:tDra , citing Hertens, ~ , at.v of F0 (~ ·:: r al Income Taxation , Vol . 7, Chap ter 39 , pp. 45 and 4 7 . ) The qtestion is:

w ~ s the purpose motivating petitioner ' s acquis i t i on of t r easu ry stock i n 1 96 4 and its r c Lent i on in 1965 for the re asonabl e needs of the bus iness·?

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- 16 - ~ To show that t here was a legiticiate a nd proper corporate object ia the above acq:J isition of tre a sx y stock by petitioner, witness f or petitioner, its chief accountant, testifi ed in court a s follows: ( •-. s. n . , pp . 2-4, February 12, 1980. )

"Atty . Quiogue With t he permission of this Honorable Court .

Q.

Mr. Supe , duri ng the hearing of March 5, 1979, among the· reasons r aised by you for j ustifying you r company!s re t ained e arni..g is the acqui s ition by your company of treasury s hares m~ king it ia capable of declar:ng cas h divide nd i as required by SEC ru ling, to the extent of t he cost of t reasury stock.

However, the acquisition of such treasury shares mus t be justified f or some cogent reason .

Could you p l ease enlighten us on· t he r easons ty which your company ac- quired treasury sh a:.e~ ?

A.

The company W3S compelled to buy SLares for the main reason that cer tain stockholders set up the: r ow ~ busi- ne s s simila~ t o ou r b1siness so that we do not want t ';·.::-m as stock- holder s since t hey are already stock- holders of c ompeting company.

And othe r steel h ol d~ rs sold their share t o t he company becaus e they resign from t he c on~any.

Q.

These stockholders who put up their own company , wou ld you say that they would constitute a threat to the c ompa~y if they r ema in as stock- holder s?

A.

Yes.

Actually they own 40 to 50% of

DECISION -

CTA CASE NO . 2500 - 17 - the ownership of the compa ny.

That wou l d afford them substantial share in the secret of the company. Q.

Is tha t actu a lly one o f the reasons why yo~ r comp2ny pur chased thei r sha~es?

A.

Actually, they put up their own business similar .to our business.

Q.

Is that business still in existence? A.

That is still in existence.

JUDGE FILLER

Q.

WhaL is t ~ e name of .the business ? A.

Filipinas Electronic ;;; .

11 No competent evidence, oral or documen t a r y , wa s presented by petitioner in support t hereof. The t ~r e s tatement of a ch ief accountant that sor:1e stockholders set up a bus ine ss si2ilar to petitioner 's, and peti- tioner had t o buy their shares, unacc ompanied by adequate evidence, has no weight with the Court . It should be no t ed that an accounta~t is no t in charge of t he adrnin ~s - tration and manag ement of a c ompany and does not usually lay down bus iness pol i cies.

There is no other evide nce in the records which sufficie ntly shows that .the acqui- sition of t he treasu ry stock wa s indeed for v a lid bu~i ness reasons as alleged by petitioner.

I n fact, the said purchase of treasu r y shares wa~ a d ra in on peti tioner' s financial resources, in view of the s ubstantial amount involved.

And even more, s aid s hares were ret a ined f or 2, 't

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DECISTON

CTA C

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DECISION

CTA CASE NO. 2:0 0 - 19 - ~here was no pro·f tha t the acquisition of t reasury stock was for the real and i mmediat2 b e ne fit of petitione r.

On t he contrary, it appears that the sa i- a quis ition was for the benefit of the stock- holders.

A hi hly im~o~tant f actor of proof in connection .

.

with a purpose to escape t ax on the stockholde r is the presence of lour: s made L o ~_; :.:.oc!~holders; such loc.:ns te nd to prove t he lac k o f necess ity of the accum·lation of surplus by t he corporatio • It has been held to be immaterial that the stockholder is willing t a pay a highe r r ate of interest than bank s or other third parties, or t hat the s toc kholder guarantees to pGy interest.

Qui e natur a lly the q~estio n immediate Jy -r i ses as to why the corporation does not pay d ivi- denJs t o i t s stoclaolders if it is able to make loans to them ou t of its Ga ;nings and profits. UJJ.ertens, Law of Fede r al Income Taxat ion , Vol. 7, Chapter 39, p. 71 .) It is clear fr om the for egoing t hat in ret3ining i t s treasury shares i n 1965 f er t he purpose of selling them on credit to i t s ~cckholders, petitioner has a llowed :Lts e a ni:1gs a n profits t.o accumulate beyond the· reason- able ne-ds of the business, wh ich i s de te rreinat ive of the purpose t o avoid the tax on its shareholders . 23 t1

I

DECISION -

CTA CASE NO. 25 00 - 20 - The other gr ounds cited by petitioner to justift its accumulation of earnings were it~ long r ange ex- pansion program and its need for more working capital .

I t is argued by peti t ioner that its surplus has ~ n fact been plowed back into its tusiness in the form of fixed assets acquired in pursuance of a long-range expans ion prog r am.

To eviGcnce th ~ i mpleme nt ati on of its long range program petitioner introduced extsnsive exhibits showing t he various a ddi~ io ns to its f'xed a3sets f r om J uly 1, 1958 to June 30 , 1967 amounting to P3 ,79 0,J20 . 77.

However, petitioner did no t submit proofs of specific, definite and f easible ~l a ns for the accumulaLion in the taxable year in qu e st~ o n .

Thu3 :

"To determine t he 'reasona:Jle needs 1 of t he bus i ne ss in order to justify an accumulatio~ of earnings, the Cour t s of the Un ited States have i .vented the ~a ­ c alled 'Imme iacy Test' which construed t he t'ords 'r easonable needs of t he bu si-~ ness' t o mean the immediate needs of t he bus iness, and it was generally he ld . t h~t if t he cor pol' tion did not prove an i ~ ediate need for t~e accumulation of the ea r ni 1gs and pr ofits , t he accumulation wa s not for the re asonable needs c f the bu s ines;:;, and the penalty tax \·leu l d e1:::?J.y ." (Manila Wine Merchant s, Inc . v. Com ~iss io ne r of Ir';tern ·· l Reve r:ue , ~u p r ::.,!..) . Such plans a s the c orporati on ha._, fo r use of ~ccumul~te~ e ~ rn i ngs mus t be in existence at the c lose DECI SIOJ.~ - CTA C ~SE NO . 2500 - 21 - ~f t he year in which the accumulat i on i $ made. In rder to de termine whethe r profits were accumulated f or the reasonable needs of the business or t o avoid the sur ta2. L,po'i shareholders, t he controlling i ntentio:1 of the t ax~ayer i s that which i s mani~ested at the time / of t he accumulation, not subsequently d c lared inten- .

tions which are me r ely the proiucts of afte rlhought . (Bus ilan Estates, Inc. vs. (:)m::1issioner of Inte rnal Reven ue, 21 SCRA 1 7 citing Jacob Mertens , J r., The Law uf Federal Income T~xat ion, Vol. 7, Cumu!ativa Suppl e- men t , p • 213 . )

Petitioner placed great emphasis on the use of the "D ardahl" formula to asce rtaln :U:.s wor king capital need., for one lY 1 s iness eye l e. AP!:jly ing the Bc..rdi..d.ll . f or mula , p _ti t ioner tried to s::ovJ ·chat i t needed f\.u:ds to provide working c apital in t he amount of ~4 , 6 72, 118.06 f or one operating cycle .

(S>:h. " J" .)

Since its net liqu i d ~ssets as of t he end of the tax year 1°6 5 was only P3 ,1.5 2, 16 5. 30 (Exh. "H-1") '· t he sho:..: tzcg e of working capi t al amountc j t o Pl, 519,952.76. (Pet itioner 's Memo- ran ~u m, p. 216, C ~A resord s .) 'l'hc use of a substantia l p.a.rt of petitioner's fu nc1s to :1cquire t rea::;u ry stock c:t:~d the rest r iction of its ea _ned sLrplus as a conseqilence of the retent ion f ·a J,..

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' o_ sa 1 SL.OCK 1n 'J-., :;;, 1s 1ncons 1stent vllL pctltloner s f~ \.

DEC IS ION -

CTA CASE NO. 250 0 - 22 - ~ l airned s hortag e of working capital . If petitioner was i n dir e need of f u~ds , then it sh9uld nG~ have burdeneJ i tself with the purchase of t re asury stoc k and the n facil itated i ts sale on c redit t o its stock- holder s.

The s a l e of sa id shares could have been made direc t ly from the wi thdrawing s t oc kholders to the r ema ining stockhol·..::e r s , withou t cours i ng tLe tr Z:nr: ~ ct i o n through the corporat j.on and the end result would have bee n the s ame .

Unde r Section 25(c) ~a lt houg h t he existence of a ac...cum~ : lat.~o n be :y·vnd the r easonable business needs i s determi n~ti ve of the pu rpose to avoid the tax uyon shareholders, the tax1 aye r may overcome the pre sumption by pr ov ing to t he contrary by a c lear pr eponde rance of t he evide nce.

The taxpayer's evi0cnce mus t be Ci~e c ted to a c0mpl ete lack f the prosc ri bed purpose , as t he c:dste nce of even a bonafide business purpose is not inconsisten t with anot her purpose to reduce the s ur - t ax b' r en of its shareholders . Income Taxat i on , Vol. 7, Chapte r 39, p . 53. ) What w~s he l d in Pelton Casting Co., 28 TC 153 (1957) ~ aff'd 251 P2d 278 (CA 7th, 1958 ) ~ci tin g Trice Produc ts Co rpor~t ion, 46 B. T. A. 346, 374 (1942 ) ~ i s appropr ia te he re and we quote:

" I f tl1e rea s o r1al)le 112eds o f tl1e business are to be re lied upon ss a means of convincing us of the complete innocence 23 ~i

I

DECISION -

CTA CASE LJD. 2500 - 23 - of petitioner' s purr c:>e , L,is must at leas t requir e a d e mons tr at~on that t here 111as a pur pose to provide fo r those business need s s o satisfying and per sJ as 've t hat it is unnecessary to l ook f urther f or a motive for the action under c riticism.

And to t his it m~st be adde d that a demonstrate d purpo se may be ' not i nconsistent wi t h anothe r pur pose t o r educe income taxes ~y hav ing a corpor ation acc umula te its gains an::-1 prof i ts r a t.. her than distr ·- bute ~he m } * * * And 'it is to this c omplete lack of the con denned purpose t ha t its evidence must be J ir ected and if it do0 s not fair ly prove an a bsence of such purpose it must fai l reg ardless of what other J ur p~s e s it may pr ove.' * * * Eve n if t he y sa t i sf i e d us that t he accumulations we re c aused i n par t by the plcn or pur pose t o pr o•ide f or re a sonable l:; 1 s iness needs : the re would remain to be 0Xamined what is enpressly E.ldvanced aS tbe principal pt.>;~ pos e. The inciden t a l ones would still appea r as excuses, o r afterthough t s , rathe r than evidence o f an a bsence o f t he purpose descri bed by the s t atute."

The Court r ecogn izes that in consonance with well- establ ished principles, the Commissione r's determination is pre s ump t ively c orr ec t and cast s upon petitioner t he burden of of f er i ng evide nc e in oppos ition thereto . The burden of proo f is on t Le taxpaye r c on t esting t he vali- dity or cor re c t ness of an assessme .. t to prove no t only t hat t he Commissioner of Internal Revenue is wrong but tli' the (taxpay.:?r ) is r i9:1t.· (Lino Gutier r ez v r:: .• Col - l e ctor of Inter nal Revenue , CTA Cas e No . 504, J an ~ ar y 28 , 24u

DECISION -

CTA CASE NO . 2500 "!... 24 - ~962;

Tan Guan v s . Court of Tax Appeals, L-236 76 , A"rl"l 27 1a6·7

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r

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- ~ ·- ~ vs . Bureau of Int erna~ Revenue , etc., CTA Case No . 3713, January 25, 1985, certiorari denied in G.R . No . 707 58, Aug. 21, 19o5 .)

And under Sec tion 25 (c) o f t he Hevu we Code , s u~J:2, 1 the fact that the earnings or &ref its of ~ corporation are permitte J to =c~umulate beyond the r co.sonable needs of tile busin -::: ss s hall be determinative c~ the purpose to avoid the tax upon i ts shareholders or membe rs un1e d ~ the corporat ion , by clear pr eponde rance of evidence, shal l prove t he contr a r y. Onc e s uch evidence i.s presented, tl::.: question tlur.:.. is whether under all the evid -nce, petitione r h iO. s sus t ained by clear pre pon~erance of evidence t he bu:de n which the statute pl~ces upon it to over c ome the presumption that it was availed of for tho prohit iteC purpose.

Such

presumpt i on arises !) y virtue of a fi nJin9 that peti- tione r accumulate profits beyond the re asona ~ le needs of its busi nes s • . When we conside r t.i:~e f ~ cts and circum- stance3 of tj~ case a3 discussed above - p~;ment of management f _es to its siste r 6ompany; history of d b-:vidend distri but ions made by pc:titioner from June 30, 1956 to Ju ne 30, 1965 ; retention of treasury stock and suusequcnt sale on credit thereof to stockholders ~ 24J.

DECISION -

CTA CASE NO . 2500 - 25 - absenc e o f specific, de finite and f easible plans f or the ace 1mu l ation in the t axable year in question - all of these ..

f ac t s and circ ums tances , taken t ogether, t end to suppor t the c onc lusicn that petit :oner was ava i led o f in the f i scal year ending June 30 , 1965 f or the purpose of pr event i ng the i mposi t ion of the t ax upon ;ts s hareholders . And because of petitioner' s fa ilur e t o sustain t he bu r den which t he l aw 2pplicable pla~es upon i t to overcome by c ea r preponde rance of evidence , the determination of respondent that petitione r was <lva i led o f f or t he prc·'·ib ited purpose in the fi sca l ye or 1n qu estion , mu s t be sustained . Accordingly, pet itione r P. I .

~anu fnct u rin g , I nc ., is hereby o rde r ed t o pay to r espondent Commissio1:e r of I ntern a l Reve nue t ~ e amount of P88 3,191. 06 representing surtax for petitioner's i ~0 r0 ~2 r accumulation of surplus for the f iscal year 1964-1965, plus sur charge s a nd interes t incident to del i nquency f.Jllrsuan t to the p r ov i sions of Sectic·n 51 (e) of the a pplicable Nat5. onal I nternal Revenue Code , as amended . ~\TH EREFORE, the clecision appealed fr om is hereby af f irrued at pet i tione r' s cos ts .

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