CTA Case No. 986 (Decision)

Republic of, the Ph ili ppines COURT OF TAX APPEALS � l.lanl.la 'RASIL1 J ESTAT ES ~ :INC. , C~ T. A. C/'.Sc NO .- 986 / Petitioner , - ve rsus - CO!�,'lJI.USS IONER OF PJTEPT�JAL. REVEhTt.JE , Respondent. X- - - - - - - - - - X DECI S I 0 N This is an appeal f r om the de cision of the res- pondent holding the petitioner liable for the payment of defi cienc y in come t ax for the ye ar 1953 in the sum of ~90,788 .75. The facts of the ca s e, as stated in the memo ran- dum of counsel for respondent , are as follows1 Petitioner is a domest ic corpora - tion organized under the laws of the Phi lippines engaged in t he business of coconut production. (p. 3 , t.s.n., hear- ing of December 5, 1962.) I t was organ- ized in 1920 'Nith a capital of 25 ,000.00 ; increased in 1942 to ~2.00 ,000. 00 ; �--500 ,- 000 . 00 in 1953 and ~1 ,000, 000 .00 in 1956 . As of 1942, the following appear as its stockholders and t~eir corresponding stock- holdings: � --- Juan s. Alano ~---- 49 ,000 shares Ramona T. Ala no 35 ,000 shares Dolores A. La co - nico 19 ,000 shares L eonora -A--. -H--iv--e-ra~--... 19,000 ~ Julio T. Ala no ------- 19,000 If! Fabian T. Alano 19 ,000 Bartolome Duma - d2 cg ------------ l9p000 Ill (pp . 10-11, Folder of Exhi bits) Juan S o Alano and Ramona T. Alano are husband and wife ; the rest of the stockholders are their children including the latter who is an adopted son (Sxh . 3, I; - --..:.._

DECISION - C.T . A. CASE NO . 986 - 2- P� 68 , PIR re c. }. Petitioner is there- fore , a close family corporation. Petitioner filed its in come t ax re- turn for 1953 on March 24 , 1954 and based on said return it paid the sum of ~8, 028~ 00 as income tax for 1953. The investigat1on of the 19~3 income tax return of the petitioner was conducted in 'Manila be cause the books of a cc ounts of the Jutaaxnpsay. ePr lawneore, being kept at the office of Inc, locat ed <J.t R.oorn 401 Mad ri ga l Building , Es colta 1 Manila (p . 191, t.s.n . hearing of December 7, 1962; pls. see also Exh . ? , p . 44 BIR rec. ). Examiners 3meterio Trinidad and Rienvenido P. Ferrer , who conducted the investigation , interviewed ; ttorney Felix A. Gulfin , the'accountant and lawyer of the petitioner (pp~ 40 & 194, t.s.n. hear - ing of De c. 7, 1962), at qoom 401 :.~adrigal uilding, Manila, who informed them that the books ~~Jere in Zam oanga at the time (p. 194 , t.s.n . hearing of De c. 7, 1962 and who ar - ranged that the books of the petitioner be brought to Manila a \Then the books of the petitioner arrived , Atty. Felix A. Gulfin showed them to the examiners at rtoom 401 Madrigal Building , ts colta , Manila , for exam - ination (p. 46 , t . s .n. hearing of Dec . 5, 1962). In a reoort of investigation dated February 19 , 1959 (Exh- 3p PP � 62-68, BIR rec. ) , Examiners Trinidad and Ferrer as - ce rtained that there is due from herein petitione r the amount of f3,912 . 00 as defi - ciency income tax for 1953 and that in the same year petitioner had unreasonably ac- c umulated a surplus of ~347 ,501.01 beyond the reasona le needs of the business on which the sum of ~"86 , 876. 85 was recommend - ed to e assessed as 25% surtax , pu rsuan t to se cti on 25 of the Tax Code , the details of v..rhich are shown hereunder : Ne t income per return as aud ited- P-40 , 142.90 Add : Overclaimed deprecia - tion, per above -~ .10 ,500 . 49 Misce llaneous e x- penses disallow- ed --------------- 6 ,759.17 19 , 560._06 Off icer's travel- ; 591702. 96 ling expense dis- allowed- ---------- 2,300 ,. 00 (Am ount carried forward I I

/ DECISION - C. I . A. CASE NO. 986 -3- T (Amount brought forward , - ~59 , 702.96 20% tax on i59 , 702. 96 -- ---- f!llp940P00 Less: Tax already assessed - 8 ,028. 00 Deficiency income tax ----- - ..- 3 , 912. 00 Add : Additional tax of 25% on 347 , 507 ~ 00 ---- 86 , 876.75 TOTAL DUE & COLLt:CTIPLE - ---- il90 p7~~ On the basis of the aforesaid report and recommendation , respondent issued assess- ment notice No. 52 - ACR-33-58/53 dated Feb - ruary 26, 1959 (Exh.. 10, p. 54-A , BIR rec .. ) addressed to the petitioner at Room 401 Mad - rigal Building , Escolta , Manila , at whi ch address petitioner 's accountant and lawyer held office .. � Petitioner having failed to pay the aforesaid taxes on the due dat~P respondent, on October 8, 1959 , issued a wa rrant of dis- traint and levy against petitioner ' s proper- ties (Exh. 12, p. 95 BIR rec. ) which was re- ceived by petitioner through its Treasurer Dolores A. Laconico on February 26p 1960~ The request for reconsideration of the assessment having been denied (Exh. N; p . 160, RIR re c. ), petitioner filed a peti- tion for review with this Court on December 20, 1960. (See pp . 1-3 , Memorandum for the Respondent. , The issues raised are: (l) whether or not the � right of the Government to collect the alleged deficien - cy income tax has already pres cribed ; (2) whether or not respondent properly disallowed the sum of ~19 ~560. 06 , representing alleged overclaimed depreciation , misce JJa- neous expenses and officers ' traveling expenses;and �Jwhether or not petitioner had an unreasonable ac - cumulation of surplus profits subje ct to the penalty tax of 25% 9 pursuant to Section 25 of the National In - ternal Revenue Code. As to the first issue, it is contende d that since petitioner's return for 1953 was filed on March 24 , 1954 , the Government had only three years from said date ?

DECISIOl'T - C- T. A. CASE NO . 986 -4 - or up to March 24 , 195,7, within which t o collect the deficiency t ax b' distraint and levy , pursuant to Sec- tion 5l (d of the Revenue Code , citing Colle ct or Va Zulueta , G. R. rJ o. L- 8840 , Feb . 8 1 1957. Se ction 5l(d) of t he Revenue Code , which a uthori zed the Commiss i on - er of Internal Revenue to co llect income tax by dis - traint and levy within three years from the elate the return was due or was filed , was re!Jealed by Re9ubli c Act No'"' 2343 , whi ch took effect on June 20 , 1959. It is admitted that the warrant of distrain t and le vy was issued on October 8 , 1959 ~ Therefore , the statute of limitation properly appli cable is governed by Se ctions 331 rlnd 332 of the Revenue Code , which provide that in - ternal r evenue t axes may be collect ed by distrain t or levy or . y judicial action within five years aft er as - se s sment. I t is argued , however , that the assessmen t was macie __. after fi ve ye ars .from the date the return was filed , hen ce , �the right to assess ha s prescribed . The re cords show that an assessment noti ce dated February 26 , 1959 , or wit hin fi ve years from the date the rEturn was f iled on IJla rch 24 , 1954 , was sent to petitioner . (Exh .. 10 ; see also letter of Regional Director of qegional District No. 3 of the _ureau of Internal qevenue , p.. 71 1 B. I . P.. . records . ) Ve a r e 9 therefore , of the opinion tha t the right of the Government to assess and colle ct the de- fi cien cy income tax in questi on has not prescri ed ~ (See Alhambra Cigar & Cigarette Mfg . Co . v. Coll ., G. R. l'Tos .. L-12026 & L- 12131 , r1ay 29 , 1959.) The se cond issue relates to the disallowance by

D2CIS I� )r~ - c . T. / . c�. sE t~C' . 986 -5- respondent of ce-rtain d' eductions claimed bj netition- er in its retu~rr. !he first item involves alleged over- depre c iation in the sum of ~ lC�, 500 ~ 49 . In p"':'evious ye~~s , petitioner c laimed depreciation allowance on cer,t<n.n asst: t s in the sum of !36 , 842. 04 . It reappraised said assets;in 1953 and claimed a depre ciation allow - an ce of r47 , 342 . 53 for said year , or an increase of ~1C , 51)Ci . 49 over: the previous year. The reappraisal of t~a value of the assets is sought to be J Lstified as follows : ��From the year 1948 up to the pre - sent time , it i s of j~dicial knowledge that our gove:r.m1ent has imposed some kind of cont rols for the purpose of p:romoting the growth of local industries and fo r the 9urposes of revenue making. In view of these ci:rcumstances , depreciable ass0ts cf any business enterprise required deDre - ciation or replacement deduct i ons propor- tionate to the increase of replacement cost brought about by the increase of ac- quisition c ost of re~la c ement equipments . ~ (Page 9 , Reply 11emorandum , 3ept . 23 , 1963 . ) Se ction �30 (f) of the Revenue Code prov i des that a tax~a yer may deduct ~~em gross in coue a r easonable a l- lowan ce for�deteriorat i on of property arising out of its use or emp l oyment i n the bus i ness or trade or out of its not being used . The total amount l'�lhi c h uay be claimed as depreciation deduction shall in no oase ex ceed the capita l invested . (3ee also Sees . 105 and 108 , Rev . Regs . Po . 2. ) !Jetitioner is c laiming a depre ci ation 'deduc t ion i n excess of the capita l i nves t ed ; it bases its depreciation deductio n on th e es t imated increased ( c os t of repla cemen t equ ipm~ nt~ This is not authorized by l aw and , therefore , the de c ision o~ res0ondent di s - �

DEC IS IOt�l - C. T � A ~ CAS c t :0 ~ 9 86 -6 - allowing the overclaime' d depreciation deduction must be sustained. The other items disallry~ed by respondent are as follows ~ Miscellaneous expenses - -- - - - 7:2 , 00LOO Miscellaneous� expenses - - - --- 4 , 758.17 Officers ' traveling 2 ,300. 40 expenses - -------- -------- Total�-- - -- ~9 , 059 . 5_7 Petitioner was unable to give a satisfactory explana - tion of said expenses. Respondent justifies the dis- allowance on the f ollowing .grounds : ~The foregoing expenses were not satisfactorily explaineJ. Petitioner did not present the recei?ts or vouchers sup - porting the alleged expenses . In the case of treveling expenses of officers, for example , the supporting 9apers , as well as check stu's are presented to the company (p . 37, t . s . n. hearing of De c. 5 1 1962 ), and yet tlte said do cuments were not oresented in evidence~ Petitioner ' s witn~ss testified that the vouchers and the supporting papers of the expenses claimed were lost on L1a rch 30 , 196 2 dur - ing the fire in Pasilan City {p. 40 , t ~ s.n . hearing of Dec . 5 , 1962 � If these re - cords were lost in 1962 , then the same caul have een produced and presented dur- ing the investigation of this case in 1959. It is t herefore quite o vious that either � the said support i ng papers did not a ctual - l y exist _e cause the alleged exoenses were never incurred or , assuming but without conceding their existence , the petitioner withheld the presentation thereof be cause the same would have worked against the petitioner had they been Presented in court . ~ From the evidence of record , we find no justification to reverse the finding and con c lus i on of respon ent with respe ct to the disallowance of the aforesaid al - leged expenses . The third and last issue relates to the 257~ penal - ty t2x on the alleged unreasonable a ccumulation of sur- (I IL

DECISION - C. T�� C:l\SE NO ... 986 -7- , plus amounting to ~47, 507 . 01 . his amount has been ar - rived at as follows : SlJRPLUS , (Dr. Pa lan ce ) 9 ~ 83 , 240~32 January 1 , 1947 -------- ------ -- 202 . 694. 1_9 Add : Profit for 1947 ----- --- --- -- SlffiPLUS ~ De c em~er 31 , 1947 ------- ~119 , 453.87 Add : Profit for 1948 ---------- -- - 316,737 . 23 A36, 191 . 10 TLOeTsAssL C--h-c-rg-e-s--a-g--a-in--s-t -S--u-rp--lu-s--: ---- 374,724. 83 Income tax --------- t24 , 323. 30 i! 61 , 466 . 27 Refund , Mrs . JareBo 200,.00 109,855.. 70 for post var right- 201.53 P171 , 321.97 Freioht for 1947 - -- 50 ,000. 00 43 , 106.81 Dividends ---------- ~ - 128 J 215 .. 16 Rese:rve for �~le ctri- 287,990. 29 fication of driers 200 9000 .. 00 Jr.-416 , 205 .. 45 & 1/ie chanizati on --- 50 ,000-00 Reserve for Malaria , 113 ,~ 68 Control & Infirmary f:303 " 77 800.00 Reserve for General :'303, 822.. 77 Research & Indus - . - 5l p445. 88 trialization ------ 50 ,000. 00 -252 ; 376. 89 SURPLUS , De cembe r 31 , 1948 --- ---- rdd : Profit for 1949 ---- --------~ __134 f 712. 22 387,089.11 TLOeTsAs L: C-h-a-r-g-e-s--a--g-a-in--s-t -s-u--rp-l-u-s--: ---- In come tax --- -- --- J". 38,008. 47 1948 expenses in 1949 not taken UP i n 1948 ------- 5 ,098. 34 SURPLUS , December 31 , 1949 ------- ~Add ~ Profit for 1950 ------------- TLOeTsAs L: C--h-a-rg-e-s--a--g-a-in- -st--s-u-r-p-l-u-s-:----- Income tax -------- ~ 13 ,1 82. 68 Dividends ---- -- --- 100 ,000. 00 SDqPLUS , December 31 , 1950 ------- Add : Rent income --- --- - --- ----- -- LOesTAs L~ C-h-a-rg-e-s--a-g--a-in--s-t -s-u-r-p-l-u-s--: --- - Loss in 1951 --------- -~ y2~0-03 Income tax 1950 ---- 46,078.. 00 Representation ex- 1 , 840. 20 oenses -~--------- charitable contribu - tions ------------ 1 ,257. 65 SURPLUS , De cember 31, 1951 ------- Add : ~ parti c ipation of Philippine r ationa1 ~1antation in 1951 less (~ of 2 v270 . 03 - 1,135. 0 1 Profit for 1952 ------133 , 577.21 SUP2LUS , December 31 , 1952 ------- Add : Profit for 1953 --- 40 ,142 k90 Reserve for Ele ctri- fication of driers & Me chani zation ---- 200 ,000. 00

DECISION ' C. T. A. CASE NO . 986 - 8 .. , Reserve for malaria c ontrol - ------ - - 50 , COO . OO 299 , 142. 90 -677 , 232. 01 TOTAL ------ --- - -- -- ----- ��- - - ---- Less : Charges against surplus : 329 .725.00 '-347 , 507. 01 w----- Expenses correspond - 250.00 ing to 1952 Income tax~ 1953 -- 29 , 475. 00 Unissued Capital Stock --- --- - - -- -- 300 ,000. 00 SURPLUS , December 31 , 1953 ------ (Exh . 3 , pp . 66 -67 , BIR re c.) Se ction 25 of the Revenue Code , which imposes a tax of 25% on unreasona le accumulation of surplus of corporations , provides : SEC� . 25 . Additional ta x on coroora - tions imoro erl accumulatin refits or surplus . a, Imposition~ tax .- If any corporation , ex cept banks , insurance com - panics , or nersonal holding companies , whether domestic or foreign , is f onmed or availed of for the purpose of prevent - ing the imposition of the tax upon its shareholders or members or t~e sharehold- ers or members of another corporation , through the medium of permitting its gains and profits to accumulate instead of eing divided or distributed , there is levied and assessed against such corporation , for each taxable year , a tax equal to twenty -five oer centum of the undistri ut- ed portion of its accumulated profits or surplus which shall be in addition to the tax imposed by section 24 s and shall _e computed , collected and 92id in the same manner and subject to the same provi - sions of law , including penalties , as t~at tax. (b) Pr~na facie evidence. - The fact that any corporation is a mere holding c ompany shall .e prim.�.....f....?cie evi den ce of a purp ose t o avoid the tax upon its share - holders or members . Similar presumption will lie in the case of an investment company where at any time during the tax - able year more th:m fifty ~ centum in value of its outstanding stock is ownedi directly or indirectly , by one person. or- (c) evidence determinative of pur- DOse . - The fact-that the earnings- profits of a corporati on are perm itted to accumulate . eyond the reasonable needs

DECISION - C. I.A. CfSE NO . 986 - 9- of the 1)us iness shall be determina - tive of the ouroos2 to avo id th e ~x upon its sha~eh~lrlers or mero _ers un - lass the corporation , -Y clear prepon - der~nce of evi en ce , shall prove the contrary. The na ture of the pena lty tax and the accuMula- ti ons of surp l us prof its of corporat i ons whi ch are tax- a le or non -t axahle are e xplained briefly in Pi col rad- in0 , Inc. v . Commissioner of Int, Re venue, C.T �� ~ o . 612, Jan . 8 ~ 1962, from whi ch we quote: Section 25 of the Reve nue Code im- ooses f or each year , in addition to the t ax im posed y Se cti on 24 , a tax of 257~ on the un is tri uted portion of th e orofits or surolus of a corooration t~Ih ich is form- ~d or ~vailed of fo~ the purpose of pre- verting the imposition of the tax upon its shareholders or mem ers or the sharehold- ers or members of -any other corporation through the medium of permitting gains or profits to accumulate instead of divid - ing or distributing them. It is a pre- requisite to the imposition of the tax that the corporation e formed or availed of for the purpose of avoiding the income tax on its sto ckholders y permitting the earnings and profits of the corporation to accumulate instead of dividing them among or distributing them to the stock - holders. If the fa ilure to pay dividends is due .to some other c~sue , such as the use of the undistributed earnings and pro- fits for the reasonable needs of the usi- ness , such pu::o::-pose does not fall within the interdiction of the stat ute . Inasmuch as puroose involves a state cf mind or in - tent , it is always necessary to inquire in- to the facts in each individual case to determine whether the purpose of the fai l- ure to maYe distribution was to permit the shareholders to avoid the inc ome tax or for some other purpose , such as the use of the earnings and profits for the reason - a le needs of the . usiness. (7 Mertens , Law on Federa l Income Taxation , ~ec . 39.26; see als o Sec. 21 , nlev . Regs . to. 2.) Some of the circumstances which in - dicate that the accumulations are beyond the reasonable needs of the business are (a' � accumuJ at ions for the benefit of stockhold-

DcCISIC :�! - C. T � . � C/S~ ~!0 . 986 - 10 - ers ; (b) loans to sh2 :reholders or the expenditure of funds by the corporation for the pers cna l benefit of the sto ck - holders ; and (c ) investments unrelated to the corporati on ' s 1Jusiness . (7 !'.'e r - tens , Law on Federal Income Taxation , ..:Je cs . 39 . 33 - 39. 36 ; Se c. 19 , Rev . Ti.eg s . l'I o . 2. On the other hand , accumulations are deemed for reasonable business needs if they are retained for (a) expansion of nlant , facilities , and activities ; b . additions to working ca pital ; and c ) acquisitions of r8lated bus i nes s . l 7 Mertens , Law on ?ederal Income Taxa - tion , Sees . 39 . 38-39 . 40 ; , ec . 21 , He v . Regs . No . 2. ) ~'etitioner seeks to justify the accumulation of surplus profits on the ground that it was necessary � for the expansion and industrializati on of its coconut industry . It appears , however, that ~h ile r,.e..s-e--rves for these purposes were set 9_ in 1948 , they we-re reverted ' to surplus in _ l953 ~ On t-is point , it is pertinent to quote from there� crt of the P. I . R. examiners : ''le wish to ste:r~e another oertinent observation which we believe points <:lenr- ly to the intent and purpose of the cor- poration to prevent the imposition of the tax uoon its shareholders. 1'Je have O})served that �~he never the accumulated earninqs or profits of the corporation tend to . ecome c onsider? le g charge s are made against the surplus account to unduly reduce the sa~e . For instance , in 1948 , when the corp ora - tion realized a net profit of f316 , 737 . 23 v~ ich swelled the surplus to f~36,191 . 10, the following reserves were c :reatud e>go i q~Jt the surp l us account: Heserve for electri - fication of driers and mechanization - . ;.,,200 ,000.00; qescrve for ma l aria control - :t-50 ,CCO.. OO; and qese::cve for Genera l R.esearch and Industrialization - t50 ,00 . 0 ; or a tot2ll of ~-3CO , OOO . OO. � These various r(~serves plus the other ch arges reduced the balance of the surplus account to only 61 , 466 . 27. It is important to note that these various reserves remained undisturbed and outstand- ing until December 31 , 1953 , when the re- serve s for electrifi cation of driers and mechanization , and the r~serves for malarial control \"Jere reverted to the surplus account . II

DECISION - C . T . A. CA E NO . 986 �- 11 - The fact that ~he reserves remained un - disturbed . and untouched shows that the projects for which the reserves we:re creat - ed v,rere never pursued or that if they were pursued the same were taken care of by the working capital of the business ; and the reversion of the reserves to surplus shows either that the orojects for whi ch the reserves have been set up are already terminated or that they are beinq a _an - doned and would not be pursued anymore. So it is clear that ~ the creation of the reserves in 1948p was in the first place . not necessary and that they merely con~ stituted an undue reduction of the sur- plus profits at the time . (P. 64 , B. I.R. records . ) Another important factor which indicates that the surplus was ac cumulated beyond the reasona ble needs of the ~usine ss of petitioner is the fact that advances in subst3ntial amounts were made yearly to officers who are at the same time stockholders. While it is true that certain expenses of the corporation were ere;.. dited aga i nst those advances , the unspent balances of " said advances were permitted to e retained by the of- ficers without being refunded to petitioner at the end of each year. These advances are , therefore , i~irect loans to officer-stockholders , a strong indication that the surplus was accumulc::-l:ed beyond the reasonable needs of the 'usiness . (See Se c. 21 ~ Rev . Regs . !.Jo . 2.) Finding no error in the dedsion appealed from, the same is here y affirmed , with costs against peti- tioner. SO ORDE"R.ED . Manila , Octo er 31 , 1963 ~ I CONCUR: '' R0!.1/.!J !-.1 . UT.lALI Associate Judge ----:~ ~ - .. MARJ'\1\10 l A~LE ~ Presiding Judge